Where’s the Money? What to Expect in 2011

Earlier in the week we gave you our rundown of the top DoD policy and procurement stories of the last year. Now, it's time to look ahead at what may be in store for defense programs to see who will win and who will likely feel the sting of budget cuts.

Earlier in the week we gave you our rundown of the top DoD policy and procurement stories of the last year. Now, it’s time to look ahead.

We asked Pentagon analysts David Berteau of the Center for Strategic and International Studies and Loren Thompson (love him or hate him) of The Lexington Group, a couple of the most insightful players on all things DoD, to give us their perspective on what’s likely to happen in defense spending in the coming year.

First off, before we go and predict anything program-wise, there’s this little thing called the FY-11 budget which still hasn’t been passed. The Pentagon is currently running at FY-10 levels through March 4 due to a temporary spending measure lawmakers approved last week. This means Congress has to tackle the current budget before the Pentagon will even think about submitting its next budget request to lawmakers, notes Berteau.

“I won’t be surprised to see DoD delay the FY-12 budget submission, because to submit one without knowing FY-11 is bad management, and Secretary Gates will not want to support that,” said Berteau in an e-mail to DoDBuzz.

This means future spending plans will be “complicated by no FY-11 baseline;” a spending package that could set the stage for $10 billion in cuts or additional funds “in FY-12 and more beyond,” he added.

Once the current budget is settled, modernization accounts are likely in for more than their fare share of budgetary pain as a Republican-led Congress tries to tackle government spending.

Historically, when defense spending declines, the investment accounts take a disproportionately large share of the cut,” said Berteau. “The pressure to do so this time will be great, because we can’t cut force structure until Afghanistan goes down (2014?) and we can’t cut operations and maintenance because we don’t know how (we take money out but salaries and invoices must be paid anyway, so we reprogram).”

Thompson somewhat echoes these thoughts, saying that ground vehicle modernization programs will be particularly vulnerable to spending cuts:

“Ground vehicle modernization will be the big loser as Congress and the Pentagon balk at high price-tags for the Army Ground Combat Vehicle, Marine Corps Expeditionary Fighting Vehicle and Joint Light Tactical Vehicle,” said Thompson. “This will create an opportunity for continued production of legacy vehicles such as the Stryker and Bradley fighting vehicle.”

Taking a particularly bitter wallop will be the parts of the Pentagon who worked diligently to trim overhead costs under the DoD’s call to save cash on everyday things like energy use and redundant facilities to free up money for procurement, said Berteau. This plan, dubbed the efficiencies initiative, appeared to be Defense Secretary Robert Gates’ effort to show that DoD could be fiscally prudent while it against major cuts to modernization accounts.

“The final complication is that those few parts of DoD who were making Gates’ efficiency initiatives work (and using the savings to fund investment) will now be punished, while those who dithered will be rewarded with cuts from a higher base,” said Berteau.

The real bad news is that if we do cut modernization cash, we won’t have a lot to fall back on since much of our military gear is already ancient, he noted.

“What makes this different than the 1990s is that back then we had lots of equipment from the Carter-Reagan buildup, but today we have less of an investment cushion to rest on,” warned Berteau. “This will come to a head as part of whatever deal is made to extend the debt ceiling, maybe as soon as late February or early March.  It’s impossible to see defense unaffected by that deal.”

The CSIS analyst added that, “Wall Street has already discounted defense stocks in anticipation of declining revenues, but they make take a second swipe later this winter. We do live in interesting times, because unlike the 1990s, the threats are not declining.”

Thompson, however is a bit more optimistic, insisting that even a Republican Congress infused with Tea Party spending slashers won’t cut big defense programs, despite all the recent talk about chopping earmarks.

“The political system is not ready to make tough budgetary choices,” said Thompson. “Interest rates are very low, making more borrowing relatively painless, while there is almost no political support for cutting entitlements, defense or domestic programs.”

That being said, one place we may see less political support for is spending on the war in Afghanistan, according to Thompson.

“Afghanistan is a small part of the budgetary challenge, but it’s easier to get political support for cutting spending over there than over here,” said the Lexington Institute analyst.

He also sees the looming budgetary pressure will lead to the Pentagon abandoning its move to “insource” large numbers of contract service positions.

“The high cost of hiring tens of thousands of new civil servants will make large-scale insourcing unaffordable,” said Thompson.

The DoD will also “provoke a backlash among contractors by trying to transfer risk to suppliers through greater use of fixed price development contracts,” said Thompson. “Some companies will follow the example of Northrop Grumman in the tanker program by refusing to bid on excessively risky ‘opportunities’.”

Speaking of tanker, the Pro-Boeing analyst (Thompson) added that he sees an EADS win in the contest, followed up by, you guessed it, plenty of people on Capitol Hill losing their minds over the decision.

Airbus will win the Air Force tanker competition but [a largely pro-Boeing] Congress will refuse to fund the program,” said Thompson.

Thompson is also bullish on the F-35; to many who have followed the troubled program, this should be no shock.

“All three versions of the F-35 Joint  Strike Fighter program will make steady progress through flight testing and concerns about the program will recede,” said Thompson. “Having now beaten Pentagon cost  estimates four times in a row and agreed to early use of fixed pricing, Lockheed will  avoid further performance or political setbacks.”

He says this despite numerous reports that the short-takeoff and vertical landing F-35B is experiencing testing difficulties and that the Pentagon is likely to reveal a revised cost and schedule profile for the jet in the near future.