Microeconomics

The most significant adjustments in the US economy from lower defense spending will occur at the industry level. Between 1977 and 1985, the number of industries that depended directly or indirectly on the military for more than 10% of their total sales more than doubled from 21 to 45 industries. A number of industries that are not normally closely identified with the military--such as optical instruments and industrial trucks-greatly increased their dependence on the defense market. Table 4 shows the share of output going to defense for selected industries. It also shows the growth in defense output over the 1980-87 period. In the case of shipbuilding, it shows that there is no longer a commercial industry in this country, in the case of optical instruments, it shows that defense output more than doubled over this period.

Source: Washington Analysis Corporation, based on unpublished data from the U.S. Department of Commerce

As we cut back on defense spending, it will have a significant impact on the industries listed in table 4. This raises important questions about the adequacy of the US industrial base to provide the defense production capabilities that we need. For example, defense output by the machine tool industry grew 52% over the 1980-87 period, yet shipments by that industry fell 48%. Defense output of electron tubes grew 53% while shipments fell 21%; defense output of steam turbines grew 52% while shipments fell 71%. There are other industries, too, where the industry has contracted while defense demands were growing. The pressures on these industries will intensify as defense demands fall. While I believe that the dynamic adjustment process is an essential part of the strength of our economic system and must be allowed to

work, there may also be legitimate national security reasons to explicitly subsidize certain industries that are an essential part of our defense industrial base.

With the concentration of defense output among the industries identified above, one might also expect that defense output would be concentrated geographically. This is true in the sense that states like California, New York, Texas, and Virginia are the largest producers of defense goods and services. However, these states also tend to be the largest producers of total goods and services. Table 5 shows that the defense share of total state output varies between a high of 10.8% (Virginia) and a low of 3.4% (Iowa). The largest defense producer, California, also has the largest economy so the defense share is just under 9%. The table also shows that some states which do not spring to mind when we think about the concentration of defense production such as Alaska, Hawaii, Maryland, and Washington are likely to be among those most affected because defense is a reasonably large share of the state economy.

The geographic distribution of the impact of defense cuts will depend on the specific cuts chosen. Cuts in personnel will have their largest impacts in Alaska, California, Hawaii, Maryland, and Virginia. Cuts in ordnance will affect Washington and California the most. Cuts in aircraft will have the largest impact on the economy of Connecticut. Mississippi will be most influenced by a reduction in transportation equipment. Without knowing the specific weapon systems Congress and the administration will choose to cut, it is not possible to say which parts of the country will be most influenced, but this analysis shows that the impacts will not be spread equally.

Summary and conclusions

Let me summarize by reiterating a few basic principles:

First, defense policy decisions should be based first and foremost on national security considerations. They should not be driven by the stage of the business cycle, by the Gramm-Rudman deficit targets, or by pork barrel politics.

Second, our economy is large enough and flexible enough to adjust to any level of defense spending that we deem necessary. There will be temporary dislocations, particularly if changes are made rapidly, but the key word is temporary.

Finally, the ultimate impact of winding down the Cold War will be very positive for the economy. As long as we can devote fewer resources to providing an adequate level of national defense, because the threat to our security has declined, we will be able to use those resources to raise our national standard of living.

Source: Washington Analysis Corporation based on data provided by Department of Defense

Representative HAMILTON. Thank you very much, Mr. Lee.

Mr. Gansler, please proceed.

STATEMENT OF JACQUES S. GANSLER, SENIOR VICE PRESIDENT, THE ANALYTIC SCIENCES CORP. [TASC]

Mr. GANSLER. Thank you, Mr. Chairman.

There is little question that the Department of Defense's impact on the U.S. economy considerably exceeds its 6 percent of the gross national product. The fact that approximately one out of every three scientists and engineers is supported by the defense budget, one in five of the Nation's manufacturing workers, and a similarly large share of the Nation's domestic capital investment in plant and equipment are defense related, clearly indicate the significant impact of defense on the U.S. economy. Historically, however, public policy has tended to address America's national security issues and its economic issues as either largely independent considerations or as conflicting areas; that is, "money spent on defense hurts the economy"-with the advocates of this position citing such statistics as how many hospitals could be built for the cost of a B-2 bomber. Only in recent years have some people begun to explicitly address the reality that America's overall security is a combination of its military and economic strength, and—even more importantly, that these two issues in today's world are strongly interrelated. Specifically, America's military posture and its economic competitiveness are both highly dependent upon the Nation's technological leadership. What is needed-and missing today—is a national technology strategy; developed and implemented through a partnership of private and public leadership. This must be an integrated strategy, considering both military needs, particularly in the changing international environment, today, as well as our industrial needs; where the latter must satisfy both our international economic competitiveness as well as our domestic work force needs.

Consider, first, the military arena. Here, it is essential that the United States take full advantage of the period of reduced tensions, yet recognize that history has shown that the Nation must maintain its preparedness. This is especially true in today's world of intercontinental missiles and nuclear weapons, and also well-armed conventional capability in many industrialized, and even less developed, countries.

Thus, the United States has to change its military strategy and its weapons procurements to meet the challenges of the 1990's. Undoubtedly, this means a shift-within defense expenditure at any level-toward greater reliance on advanced intelligence systems— to provide the needed "warning" associated with a reduced state of readiness—and also a far greater emphasis on research and development-in order to position the Nation for potential future needs. It also allows you to eliminate any "technological surprises" by potential adversaries. It also undoubtedly means significant restructuring of the forces, in order to be able to handle the U.S. role in "likely" Third World conflicts, as well as to continue to deter the use of any nuclear weapons anywhere in the world.

One of the most critical issues for the Department of Defense is that of being able to develop lower cost, higher quality weapon sys

tems so that, with its more limited resources, it can still afford to have a significant quantity of weapons to represent as viable deterrent and war-fighting posture.

Interestingly, it is this need for the DOD to have lower cost, higher quality weapon systems, combined with the fact that, today, the technology needs for defense greatly overlap those of the civilian world-in such areas as advanced electronics, supercomputers and associated software, new structural materials, and advanced manufacturing equipment-that leads to shifts toward civil/military integration. It is the combination of the overlap in the technology, plus the fact that DOD needs low cost, high tech systems that offer enormous potential for simultaneous benefits to the Nation if investments for defense can be effectively utilized by the civilian economy.

Historically, the Department of Defense has always been so “different"-in its way of doing business-from the civilian economy that the two industrial sectors have been totally separated-except on the accounting books of some corporations. However, the basis for these differences-such as unique military specifications and standards, specialized cost accounting requirements, excessive auditing, unique procurement regulations, et cetera—are no longer effective or affordable, and they all must be removed.

The Government must shift DOD business toward far more integration of defense and civilian operations—at the factory floor and engineering design levels. Were defense business to be shifted in this direction-a difficult step, requiring strong legislative and executive branch leadership-then the DOD could benefit from the cost and quality emphasis of the commercial world, as well as the "overhead absorption" associated with the large, integrated operations, while America's commercial industry can benefit from the DOD's large investments in R&D-about $38 billion a year-capital equipment, and labor and management skills.

At the same time as defense procurements need to dramatically improve-in terms of reduced costs, higher quality, and faster developments-the United States needs to take active steps to improve its international, commercial competitiveness in these identical areas. Numerous studies have shown that the three major factors of industrial productivity growth are process innovation-manufacturing tools and techniques-product innovation-R&D on both old and new products-and management innovation-through the development and application of new management techniques. While the DOD and U.S. industry, in general, have been extremely strong in the development of new products; however, they have been far weaker in the manufacturing area and in the rapid application of new management techniques-such as "concurrent engineering" and "total quality management." Because of the DOD's significant role in the overall U.Š. economy, if it shifts its practices toward placing far greater emphasis on manufacturing technology and on improved management processes, then the DOD's effect can significantly speed up the essential change in the U.S. industrial practices across the board. In the last few years, it has initiated some steps in this direction.

Additionally, because today there is so much overlap between the technologies used on the civilian side and those used on the mili