choices made, the actual experience of the next ten years may prove quite different from the forecasts of economic models. The impact of these decisions over the next decade are hard to forecast and imply the need to deal with a much large policy issue facing the Congress: how to formulate social and economic development strategies (research and development, job training and infrastructure investment, among others) which will prepare the U.S. economy for the 21st century. Defense dollars may play a role in these new policies simply by being one source of funds to help meet their fiscal requirements.

THE EFFECT OF CUTS ON INDUSTRY, EMPLOYMENT AND LOCAL ECONOMIES

If the macroeconomic effects of the projected defense cuts (and even of cuts that are deeper than those under discussion) are likely to be small, then the most significant issue for the Congress may be the consequences.of such.cuts for.the.microeconomy for the industries, work force and communities where defense production takes place.

Here, too, the impact of the pending cuts should not be inflated to a "sky is falling" scenario, though such thinking seems to be typical of the way we deal with many public policy problems. Several features of the reductions under discussion should be noted:

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• Although there is little detail, as yet, from the services, preference in budget adjustments over the next five years may be being given to cutting force structure rather than military hardware. This trend could mean major reductions over the next five years in Army divisions (as many as 3 cut), Air Force air wings (as many as five cut), naval forces (as many as two carrier battle groups cut and 62 ships retired), and military personnel (as many as 250,000 fewer, or 12 percent of the current active duty forces). By contrast, there has been relatively little discussion of military hardware, especially of the cuts that might be considered in hardware programs that constitute the next generation of military weaponry: LHX helicopter, FAADS air defense programs, ATACMS missile (Army); A-12, Seawolf submarine, Arleigh Burke destroyers, LRAACA anti-submarine warfare plane (Navy); B-2 bomber, ATF fighter, Advanced Cruise Missile, C-17 cargo aircraft, AMRAAM missile (Air Force). One might still expect some cuts or stretchouts in current hardware programs, such as those proposed in the FY 1990 budget. However, to the degree that the services draw their budgetary wagons in a circle around the military hardware, especially the next generation, the local, specific impacts of cuts could be smaller than expected.

• The direction of current arms control negotiations appears to reinforce this trend toward cuts in force structure, rather than hardware. From what we know of the current status of the START negotiations, the forthcoming treaty is likely to have only a minimal impact on strategic hardware production, cutting perhaps only $8 billion from anticipated hardware plans of over $140 billion.3 The

See Stephen Alexis Cain, The START Agreement: Strategic Options and Budgetary Savings (Washington, DC: Defense Budget Project (DBP), July 1988) and Cain, Strategic Forces Funding in the 1990s: A Renewed Buildup? (Washington, DC: DBP, April 1989).

current negotiations on conventional force reductions could result in marginal reductions in U.S. forces deployed in Europe, with deeper cuts in a second round. However, these cuts are unlikely to lead to the termination of current service hardware modernization programs any time soon, since they will likely involve the withdrawal of existing, older hardware.

It is also important to keep in mind that, according to DoD projections, the Defense Department continues to carry a significant backlog of appropriated but unexpended funds, projected at $260 billion as of the end of FY 1989. This backlog has risen considerably over the 1980s (from $92.1 billion in FY 1980), due in large part to the emphasis in the defense buildup on hardware procurement and R&D. For at least the next two years, the impact of slowly declining defense budgets is likely to be marginal on firms with existing contracts. Thus, for example, a highly.defense-dependent firm such as Northrop would probably carry at least two years of production backlog from current obligations for the B-2 bomber, were the Congress to cancel the program.

There may be time to plan for and deal with the local impacts of such cuts or deeper cuts as they occur in the 1990s. The local impact of defense cuts is likely to vary, depending on which systems are eliminated, what part of the defense industry is affected and where the work is located.

Rather than being monolithic, the defense market is complex and diversified. Only a few large contractors depend heavily on defense and nothing else -- principally Lockheed, Northrop, General Dynamics, McDonnell Douglas and Grumman. Each of these contractors is developing its own strategy for a transition, including diversification inside and outside the defense market and down-sizing of the company. None of them is likely to go belly-up because of the kind of cuts under discussion, especially given their importance as national production assets. Others, such as Boeing, Tenneco, Litton, Textron, Martin-Marietta and Raytheon, are more diversified, with substantial commercial business to cushion the impact of a decline in anticipated defense business. Boeing may be the limiting case, having a current $85 billion backlog of aircraft orders, of which 90 percent is for commercial transports.

Still others, such as General Electric, IBM or Texas Instruments depend only minimally on defense and have a significant corporate capacity to adjust, while companies like Hewlett Packard, Royal Dutch Shell, Exxon, ARCO, Chevron and Pan Am sell essentially the same products to the Defense Department as they do to commercial markets.

Effects on the subcontracting markets are harder to project. Subcontractor companies, such as those making machine tools or bearings, could feel some effect, though most are in commercial markets and, if a recent study by the Center for Strategic and International Studies is correct, many may have left the defense market over the past decade. There is room here for more research, since the amount of subcontractor

Center for Strategic and International Studies, Deterrence in Decay: The Future of the U.S. Defense Industrial Base, (Washington, DC: CSIS, May 1989).

dependency on defense is unknown. It is known that as defense business shrinks, many prime contractors tend to pull subcontracting business back into their own plants, creating a more serious problem for the subcontractors.

The impact of defense cuts on communities will also vary. The prime contracting defense industry is concentrated around the rim of the United States: from Bath Iron Works in Maine, down through Electric Boat in Connecticut, through Grumman on Long Island, Martin Marietta in Maryland, Lockheed in Georgia, the space industry in Florida, Litton's Ingalls Shipyards in Mississippi, General Dynamics, Bell, and LTV in Dallas/Ft. Worth, Hughes in Arizona, the numerous companies in California and Boeing in Seattle. Depending on the type of budget changes or cancellation, initial impacts would be felt in some of these areas.

Defense geography is also another. important area for further research.. Unsystematic data indicate that virtually all local economies heavily involved in defense production are to some degree less dependent on such production today than they were 20 years ago. Local economies in Long Island, Maryland, Florida, Texas, California and Washington are significantly more diversified than they were in the 1960s, making the adjustment problem different and perhaps more tolerable now than it would have been. For many localities, the days may be gone when contractor closings meant turning out the city lights. The Sacramento area, for example, with four major bases and a major prime contractor in the region, has seen the defense share of its labor force fall from 15% in 1965 to 5% in 1985. Although defense accounted for 40% of manufacturing employment on Long Island in early 1987, one study has noted that manufacturing overall, as a share of the Long Island economy has fallen from 18% of total nonagricultural employment in 1976 to 15% in 1988.5

Finally, the impact of cuts on the defense work force will also vary, depending on the location and nature of the cuts. Some changes have already occurred. DoD estimates that industry employment, for example, fell 140,000 between FY 1986 and FY 1989, a drop of 4.1 percent, with very little public discussion of the adjustments this might have required. The defense work force is not monolithic; it contains a higher proportion of scientific and technical talent and skilled production workers than the national labor force, making parts highly reemployable, depending on the overall state of the economy. The exact distribution of these workers can differ dramatically between shipbuilding, aerospace and electronics, for example, making predictions about employment effects dependent on the specific cuts being made. The impact of cuts on the labor force will also depend on the speed with which they take place; attrition in the overall labor force may absorb some share of the decline.

5 Of course, there may be other vulnerabilities introduced in a local economy by significant growth in service industries with a shrinking manufacturing base. Long Island Regional Planning Board, Maximizing the Potential of Long Island's Defense Sector in an Era of Change, (Hauppauge, NY: Long Island Regional Planning Board, 1988).

6 See Congressional Budget Office, Defense Spending and the Economy (Washington, DC: CBO, February 1983), Table A-11.

THE ELEMENTS OF ADJUSTMENT POLICY

Though they may be less dramatic than current rhetoric suggests, cuts in defense over the next decade will have an effect on specific contractors, workers and communities. In assessing the requirements for private sector and public sector response, it is important to keep in mind that our economy has been through many defense- and non-defense-related economic adjustments, suggesting some lessons to be learned and tools with which we can work. We should learn from that experience and not reinvent the economic adjustment process.

Defense spending fell from 38.7 percent of GNP in 1944 to 3.2 percent in 1948, with 10 million people leaving the military services, 1.7 million people leaving civilian employment in the defense public sector and 12.4 million workers leaving the defense industry. This demobilization was the only major experience the U.S. has had with what was then called "reconversion." For the veterans, programs included the G.I. bill, counseling, a readjustment allowance and several loan programs. For industry workers there was no planning for retraining or reemployment, but unemployment insurance benefits existed. For the companies, contracts were terminated promptly, with termination payments. Industry adjusted its activity using these payments, the saved capital from war profits and low interest rate loans. The key to successful adjustment was the broader state of the economy: pent-up wartime consumer savings, available capital, a tax cut, and relief programs for Europe all stimulated demand.

The military buildup for the Korean War was not followed by as dramatic a shift: 800,000 left the military, 300,000 left the civilian Defense Department payroll and the share of GNP spent on defense fell from 13.4 percent in 1953 to 9.4 percent by 1956. There was a slight economic dip, but the economy remained basically strong and the adjustment took place without special mechanisms or plans.

After the Vietnam War, 1.5 million people left the military, 1.2 million people left DoD civilian employment and the defense share of GNP fell from 9.6 percent in 1967 to 5.6 percent in 1974. There was some active governmental thinking about the transition, including a report on the transition from the Council of Economic Advisors to the president. Few policies were developed or implemented for the transition, however. Unemployment rose and the economy experienced difficulties, but changes in the national and international economic context the end of a stable dollar, the Nixon price freeze, the start of stagflation, a sharp decline in the commercial aircraft market and the 1973 oil price increase may have had a greater impact than did the end of the war.

There are continuous defense-related adjustments throughout wartime and peacetime, moreover, as new defense programs begin, contracts end and plants and bases close. Though such transitions are not easy, there are a number of significant examples of community, work force and industry response to such changes, based largely on using the community as the focus of the adjustment effort. A survey of such

7 U.S. Executive Office of the President, Report of the Committee on the Economic Impact of Defense and Disarmament, Gardner Ackley, Chairman (Washington, DC: Government Printing Office, 1965).

transitions by the Defense Department's Office of Economic Adjustment suggests that the reuse of military bases closed between 1961 and 1986 led to a net gain of nearly 44,000 jobs (a loss of 94,424 civilian jobs followed by the creation of 138,138 new jobs).

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Moreover, defense is not the only area in which the U.S. economy adjusts to change. The impact of declining defense budgets, base closings or contract terminations is not especially different from the impact of other economic dislocations, such as plant closings, loss of private sector contracts, the decline of an industry or foreign

competition. Because such adjustments have occurred before, local, state and federal governments have developed policy tools to deal with the transitions. These experiences have also provided tools and lessons for the adjustment effort that might accompany the coming defense builddown.

The process of economic-adjustment-is-not an easy one, nor does it happen swiftly. Above all, in considering the adjustment efforts that might be required in the 1990s, the Congress needs to emphasize the flexible use of existing tools. Beyond the need for a growing economy, a successful adjustment requires cooperation between the corporation, work force and community with adequate federal, state and local support for worker adjustment and community development. This effort needs to be geared to the specific needs of the locality; there is no single national policy which can fix every situation.

The Economy

The state of the local and national economy when the adjustment occurs is critical. A well-laid plan and strong community efforts can easily be frustrated by a weak economy; a poor plan or no planning at all might actually succeed if the economy were healthy, creating new job and investment opportunities. Policy-makers should consider the possible need for demand stimulation as an element of federal macroeconomic policy which could create a positive economic context for such spending changes.

Corporate Response

Though we tend to assume a public sector response is the most important dimension of adjustment efforts, the corporate response to economic change is absolutely critical. We should not neglect the role of the private sector, but should encourage the use of corporate capabilities for research and planning. Corporate actions can be helpful or harmful, ranging from plant relocation to corporate diversification through acquisition (United Technologies), internal corporate product development (Kaman Corp.), the investigation of new markets for existing products and corporate support for benefits, relocation aid and employment advice to an affected work force (Rockwell International, Mack Truck). Studies by the Battelle Memorial Institute and Fantus Corporation show mixed success in efforts across the different areas

Department of Defense, Office of Economic Adjustment, 25 Years of Civilian Reuse: Summary of Completed Military Base Economic Adjustment Projects, 1961-1986 (Washington, DC: OSD/OEA, May 1986).