The CHAIRMAN. What do you do if the contractor says, "I can buy them at a certain price," like the F-14, and years later he says, "No, I can't"?

Mr. JONES. If he has the right contract in the beginning

The CHAIRMAN. You make him come through at the price he established to begin with?

Mr. JONES. Surely.

The CHAIRMAN. Supposing you have a situation in which a company could not meet the price stipulated in a fixed-price contract and did not have the ability to absorb the loss. Would you advocate that he be allowed to go into bankruptcy?

Mr. JONES. As you know, this is a subject of concern to everyone. I happen to think of the bankruptcy laws where the key wording really is "reorganization." If a customer wants a product and if a company can build it but does not have the financial structure to support it, the company should be reorganized.

The CHAIRMAN. I agree; "bankruptcy" is not such a bad word. That is the price you pay for our system. Some people succeed and do well; others go under. The average small business retailer lasts 6 months and then he goes under. It is a tough situation for that average small businessman but that is the reason why we have an efficient system by and large.

Do you believe there is any realistic political chance this will be permitted or do you think there will be another bailout by the Department of Defense? Or where there is a State involved which has members of the Appropriations Committee or has people in the administration, they have their friends here, that is a big part of the problem?

Mr. JONES. I think it is. I think the so-called secondary concerns which are important; I am not minimizing them--many times govern the primary concern, which is national security. What I am suggesting is that national security should come first and that secondary concerns should be dealt with afterward. I don't mean they should not be. Employment is important.

Many times when you are talking in these terms, you are talking about financial restructuring; you are not talking about moving plant and equipment or affecting employment. What you are really talking about is that you have a mismatch between the financial strength of the company and its commitment to the Government.

Like in any reorganization, the Government may have to negotiate with the creditors to pay a higher price but it is done in the context of a reorganization. So what comes out is a better match of financial responsibility and commitment.

The CHAIRMAN. That is where you have to be careful. You deal with the contractor at a higher price but you make sure, as you say, it is done in the context of reorganization, which means either you are dealing with a new firm because they have defaulted and have gone into bankruptcy or you are dealing with new management they have reorganized.

Mr. JONES. The banker may have taken a little bit of a reduction, too.

The CHAIRMAN. That is right. Do you think it is common for contractors to knowingly make unrealistic low estimates, knowing the contract will have readjustment-in other words, buy-in?

Mr. JONES. I prefer to use the word "optimism." A buy-in can be an investment if it says: "Look; it really costs us $40; we will sell it to you for $30 and we are going to pay the difference." That means I am going to invest.

The CHAIRMAN. That is why the fixed price is so fundamental. If you are going to buy under a fixed price and produce, that is great. Mr. JONES. Make sure he buys.

The CHAIRMAN. They may take a licking on the first one, as you say. They may come through later on. That may be an element of optimism. I am talking of a situation where you buy in with a contract that can be adjusted or a weak-kneed negotiator on the part of the Defense Department will say: "We see that you can't do that; we will put the price up." The contractor knows that and therefore makes a bid that is lower than his competition.

Mr. JONES. Yes.

The CHAIRMAN. That is not uncommon, is it?

Mr. JONES. No. The form of contract speaks more loudly than words.

The CHAIRMAN. The way you do that is to insist on meeting the contract terms and to have fixed-price contracts, is that right ?

Mr. JONES. Right. When that happens, everyone is serious about the contract. It is the degradation of respect for the contract on both the part of the Government and the contractor that causes overruns. I don't blame industry alone; if both Government and contractor respect. the terms of the contract at the outset things will be pinned down and things will work out as planned.

The CHAIRMAN. In your prepared statement, you refer to competing alternative solutions to defense needs. By this are you suggesting that the military should get away from detailing rigid specifications, rely more on contractor solutions for a general statement of needs?

Mr. JONES. That is a factor. When a commercial airline buys an airplane, it really gives requirements in terms of the end result they want. They don't spell out all the details of how they get that. That is not so much what I had in mind. What I had in mind was that in the force structure you should always have in mind competing alternatives. It does not mean a different manufacturer building the same airplane. Alternative solutions are important to budgetary integrity, and that is really what I meant.

The CHAIRMAN. I have been concerned about the haste of the military to put systems into production before development and operational testing have been completed. Do you agree that that pressure to push a system along can lead to some of the problems you have identified such as reprograming, overruns, program modification?

Mr. JONES. Yes.

The CHAIRMAN. Do you believe these negative effects would outweigh the benefits in making a smooth transition to production?

Mr. JONES. It is improper to answer that as a general response. If sufficient knowledge is in hand technically, knowledge sufficient for both parties to be willing to commit, that usually is a good sign that the

more efficient program is the one to follow. If they are unwilling to commit, certainly you should not push it ahead. Once again the contract is a discipline provider there.

Our T-38 is a good example, or our F-5E program. We accepted a fixed-price development and a fixed-price production with five options before we started the development contract. We ended up with that program 18 months ahead of schedule. Why? Because we had the knowledge in hand and the Government was convinced we did. In that case, we would not say: "Wait until the development is finished and then see if it works."

The key was our ability to commit and the Government's ability to recognize we could commit. If you generalize, in an advanced program there is a lot of risk in it; you might say: "We are not willing to commit at this time but we will commit at this date." The Government will say: "You are right; we will do it."

But you should not make it a generalized rule. It depends on the particular program and the willingness of both the customer and the company to commit; that is the discipline.

The CHAIRMAN. Last year the Defense Department announced a new profit policy, that they would recognize capital investment in profit. rates. Many of your suggestions have to do with increasing investment of Government contractors and lessening of reliance on Government-furnished equipment.

Do you think that the new profit policy has been or is likely to be successful in its stated purpose of encouraging contractor investment in productivity and enhancing equipment?

Mr. JONES. Yes. I think anything like quick writeoffs and these things do encourage expenditures for plant and equipment. I think from that point of view we will see that result. I think the most direct way to do-and, Mr. Chairman, I admired your letter to the Wall Street Journal that made the point-the best way is to reduce the overall tax so the contractor has the ability to balance between labor costs, shall we say, and plant and equipment cost.

When you itemize the expenditure for plant and equipment it will allow you to buy more plant and equipment. That is good. It would be preferable if the overall tax burden, as you suggested, were reduced; then you could put demand on the lowest price.

The CHAIRMAN. We are making progress, incidentally, on that. You notice the New York Times came out in favor of repealing the corporate income tax.

Mr. JONES. It is the most direct way to handle it because it is up to the company.

The CHAIRMAN. It is a way to eliminate corporate featherbedding, too. After all, the reason you have all kinds of perks and people are so wasteful in hiring people they don't need and so forth is that the Government pays the bill. You also have the fact that a vigorous new growing company cannot now compete to a point where it is an important factor.

If we had the same corporate tax rates we have now in effect at the turn of the century, none of the corporations that are really big now could have grown to their present size. They grew under those circumstances of lower taxation.

Mr. JONES. If we did what you suggest, we would not need to make an incentive on the elements of cost because the corporation would decide: How can we produce a better product at a lower price? By putting money in research and development? By reducing expenses? By new plant and equipment? Then you get best use of the private

sector.

The CHAIRMAN. I have one final question before I yield to Congressman Evans. I spoke in the beginning about the jurisdiction of this committee being one that was concerned with the capability of our economy as a whole to support a defense effort, a military effort. How do you view our overall economic capabilities-that is, our capacity, the capacity of our factories to produce what we need, our technology, the level of our technology to meet the challenge of potential adversaries, our productivity, the efficiency of our labor force?

Do you think we have a sufficient capability of meeting whatever threat might develop or do you think we ought to be more concerned with that and be working to change and improve it?

Mr. JONES. Mr. Chairman, I think inherent in our system, we have the capability, but to harness that capability we need to go to the sound practices that I am talking about, make the defense industry more like the rest of our industrial capacity. When that happens, I believe, we can tap the broad base of industrial capacity we have. If we trust it as a special item I don't think we can take advantage of the strength of our overall system.

I think it is important to tighten up our procurement practices and our budgetary integrity through the ability of the Government to say what it wants, demand from the industry that it give it to them, and then both sides act firmly in delivering the promise.

On the Government side, don't move programs around as much. I understand that you have to modulate. But try to establish firm plans, pin the contractor down as well as the Government.

The CHAIRMAN. So you feel we have economic potential, we have economic capability, we have the work force, we have the technology, we have the productive capability; what we need to do is to organize these to use them in a much more efficient way than we have in the past and your suggestion would meet that objective?

Mr. JONES. Exactly.

The CHAIRMAN. Congressman Evans.

Representative EVANS. Thank you, Mr. Chairman. I apologize to Mr. Jones for not being able to be here for his opening statement.

I have not had a chance to study thoroughly all of your testimony. This is a very important issue. I would like to ask you a few questions before I have to leave again. Do you think there has been recent improvement in the Department of Defense's contracting methods? Do you personally see any improvement in that regard?

Mr. JONES. Absolutely. I think one area where there has been a gradual and important improvement is in personnel. The military personnel has done a first-class job in identifying individuals that will be good in procurement and sending them to school. You have a very well trained, capable body of procurement officers in all three military services. That has been a very major improvement in the last 20 years. Representative EVANS. Do you see any other improvements of that magniture or is that really the only one that really stands out?

Mr. JONES. I think we are all concerned when things don't improve as fast as we know they can and should. My remarks have to do with the fact that I think we can be much better than we are. There have been real improvements. There has been recognition that some of the past practices have not been good. We are no more tied to the old boomand-bust concept of defense. But I think we have a long way to go.

Representative EVANS. Would you say that there is strong enforcement of these contracts today or is there hope for stronger enforcement of these contracts?

Mr. JONES. Yes, but I would not put it all on the Defense Department. I think the whole Government, including the administration at all levels and the Congress as well as industry should say: "Look; we have a long pull; efficiency is going to be very important; let each of us be willing to commit more firmly than in the past."

Budgetary integrity is not impossible, because the budget procedure of the Congress is an important tool in the respect that the Congress will share with the President the responsibility for the overall budget. No longer can it say, "Well, put this one up and this one down," without considering the side effects.

What I am saying is that because of the tools in Government, the industry now should be charged more specifically and directly as to schedules, costs, quality and performance at the time the system goes into the force structure. We definitely can improve in that department. That is the greatest weakness I identify, in my judgment. Representative EVANS. I was especially interested in an excellent point in your testimony where you mentioned private enterprise investors and so forth have no trouble recognizing distinctions between companies, that the Government should be no less discriminating. A lot does need to be improved in that regard.

As you know, the C-5A contract was supposed to be a fixed-price contract and it did not turn out that way. How do you recommend that the Defense Department persuade industry that it means business better than it has in the past?

Mr. JONES. By sticking with the terms of the contract. When a Government buyer starts changing it and maybe doesn't insist on negotiating the cost of the changes and getting them approved, that is a lack of respect for the contract.

On the other hand, if the company says, "Well, if I deliver a good product I will be paid"-that used to be the idea; there was never any lack of determination to build a good product. It used to be that if it was a good product, useful, we would be paid. Now you are adding something to it: "You will be paid exactly what we agreed you should be paid when you accepted responsibility." It takes both sides to respect that contract-the Government and the contractor.

Representative EVANS. And perhaps a return to some of the basics involved here?

Mr. JONES. Precisely.

The CHAIRMAN. Thank you for your testimony, Mr. Jones. You have been a most persuasive witness, and the committee appreciates your appearance. I agree with much of what you say. This concludes our first day of hearings into the defense industrial base.

What has been said here today indicates that defense industry may be unready to provide the support needed for the defense establishment