Defense cuts inevitable, but impact depends on location and pace of change

David Fettig | Managing Editor

Published June 1, 1990  | June 1990 issue

There is a sign at Malmstrom Air Force Base in Great Falls, Mont., that reads: "Peace ... is our product."

Peace production, however—like most everything else—is subject to the laws of supply and demand. In a world of crumbling dictatorships, Warsaw Pact dissolution and nuclear arms treaties, threats to peace—at least for many western countries,—appear to be decreasing. Likewise, the demand for "peace-keeping" products that the Malmstrom sign refers to, such as missiles, planes and troops, is also decreasing.

The irony, of course, and the fear of many politicians and some elements of the business community, is that the American military—over half of which is dedicated to the defense of Europe—may have worked itself out of some jobs.

But while many fret about lost contracts and reduced employment, others—citing the so-called peace dividend—maintain that reductions in defense spending will ultimately have a positive effect on the nation's, and the Ninth District's, economy. Given the likelihood for some type of defense cuts in coming years, three issues largely frame the domestic economic debate: the overall economic impact of defense cuts, the specific areas that will be hardest hit by the cuts, and the ability for businesses and communities to adapt to the change.

In general, the analysis in this fedgazette shows that while pockets of the Ninth District economy may be adversely impacted by a defense builddown, the district's economic diversity should minimize any overall negative effects.

On a historical scale, impact will be marginal

The question of economic impact will ultimately be answered by the administration and Congress. Currently, Secretary of Defense Richard Cheney is proposing 2 percent annual cuts in the defense budget through 1997, but many believe Congress will insist on deeper cuts, probably in the 5 percent range.

A recent study by the Congressional Budget Office (CBO) compares current budget options with past defense builddowns. For its analysis, the CBO projected the impacts of 4 percent, 7 percent and 10 percent reductions in defense spending over a five-year period, and found that each option compared favorably with historical examples.

"For all three alternatives [4, 7 or 10 percent], the decline in real defense budget authority and the decline in the defense budget's share of GNP are slower than those experienced during the period of defense reduction that followed the Korean War (1952-54). All three alternatives would also reduce the defense share of GNP more slowly than was the case during the five-year period following the peak of spending during the Vietnam War (1968-73)," writes G. Wayne Glass in the CBO study.

So, in historical context, the CBO report downplays the supposed negative effects on the nation's economy. "It's not going to hurt too badly," Glass says of the eventual defense cuts, pointing out that the defense industry accounts for just 6 percent of GNP. "If you put it [the defense budget] in context, it doesn't have that much impact. But it certainly covers the front page."

The CBO study also suggests that defense cuts are good for the country. "Cuts in defense spending should result in higher U.S. standards of living," according to Glass, who cites reduced taxes and a lower federal budget deficit. He also adds that in the long run, cutbacks in defense spending might help improve productivity as non-defense research would benefit from increased scientific and technological resources.

Such an analysis may imply that big defense cuts are the best; however, long run considerations often give way to immediate repercussions, and Glass' econometric model shows that large-scale reductions in defense spending would probably cut the growth of real gross national product (GNP) and raise the unemployment rate by a small amount in the short term. But defense cuts will not, Glass stresses, cause a recession.

How should cuts be dispersed?

Once the level of cuts are set, the most problematic decision—both from an economic and political perspective—will be to determine which branches of service, and which weapons programs, will take the budget hits.

Cheney's defense reduction plan will probably be relatively kind to the Ninth District. In June, the secretary of defense proposed cuts over the next five years that would retire six active duty Army divisions, 111 Navy ships and 11 Air Force tactical fighter wings, and remove 442,000 men and women from the 2.1 million active duty ranks. California and states in the East would be hardest hit by the proposal, analysts believe.

"Cutbacks in defense have their greatest effect on three of the nine census regions in the United States—New England, the Pacific Region and the South Atlantic region—where defense spending is most heavily concentrated," according to the CBO study.

Regional impacts are expected to vary depending on whether cutbacks focus on Department of Defense employment levels or on goods and services. "If large cuts are made in employment levels, the South Atlantic and Pacific regions could experience a disproportionate impact since these regions have the largest concentrations of people employed by the Department of Defense," the CBO says. On the other hand, if reductions are targeted at purchases, "New England and the Pacific regions are likely to be the hardest hit since they are the major beneficiaries of defense purchases."

In a sense, the Ninth District is a microcosm of the nation: If cuts are focused on personnel, the district's western states—where four of the air bases are located—would be hardest hit; if procurement is targeted, the Twin Cities would face the biggest cuts.

But regional impacts can be overstated, according to James Morrison, vice president for policy of Business Executives for National Security, a non-partisan association of American businesses. For example, Morrison says that even if the defense budget were cut by one-third, Southern California's vibrant economy would still create about 900,000 new jobs by 1995. And Seattle, another potentially big loser if large cuts are made, will also fare well, Morrison says, especially because of Boeing's booming commercial aircraft market.

Steven Malin of the Conference Board's Economic and Business Environment Program, believes the Army will be the hardest hit of the military services, while the Air Force will only suffer moderate cuts. That would also be good news for the Ninth District, which depends on the Air Force for much of its defense dollars. Malin says there is even talk in Washington suggesting that the Marines be disbanded as a separate military division.

Ability to adapt is key to economic success
for businesses ...

For successful economic adjustment to occur—regardless of the size or location of the cuts—Glass of the CBO says the crucial factor is the rate of change.

"The more rapid the cutback, the more likely the disruption is to be serious—particularly for the Department of Defense, for military and civilian personnel, and for the smaller communities and companies that are most apt to experience harsh effects," he says.

Morrison, in recent testimony before Congress, advised it to treat defense contractors as underlying assets and resources, not just as product lines and brand names. He said Congress should focus on the potential of those assets, rather than on simply saving the company.

"Focusing on 'saving the company' rather than making the best use of assets and resources will only undermine the 'felt commitment to change' in the company and shortchange the company's surrounding community out of potential economic growth," Morrison said.

Despite his advice, Morrison said be expects Congress to have a "save the company" philosophy when it sets defense cuts, but he also expects Congress to do a better job now than it would have done 10 years ago. "They know more about economic adjustment these days," he said.

... military site communities ...

For any military bases that may be closed in the coming years, and especially for the communities that will be affected, all is not lost: The Pentagon's Office of Economic Adjustment reports that for the 100 bases closed between 1969 and 1986, average civilian employment increased about 50 percent after the military left. According to Morrison, the reasons are clear. "The military leaves behind valuable assets—land, infrastructure like water, sewer, gas and electricity lines, and reusable buildings. Often it leaves behind airstrips, deepwater harbors and rail lines."

Success stories abound at vacated base sites, like in Kinross Township on the Upper Peninsula of Michigan. There, in 1976, Kincheloe Air Force Base was closed, removing 10,000 military personnel and dependents, 700 civilian jobs and a total payroll of $28 million. Within 12 years after the closing, however, four prisons and one work camp were installed at the base, along with 12 industrial companies and 15 retail businesses. In all, the local tax base has doubled, and the civilian payroll created by the new ventures has reached $110 million.

Morrison cites Kincheloe as a shining example of private business profiting from supposed calamity. On the other hand, he cites Glasgow AFB of Glasgow, Mont., which began shutting down in the late '60s, as an example of failed local policies. When the base closed, 16,000 people left the Glasgow area, a trend that has been continuing among the civilian population as the base and all its infrastructure remains almost completely idle. In 1970, Glasgow had an emigration rate of 33 percent; in 1980 the population fell to 4,500, and it is expected to fall below 4,000 this year.

... and local economies

In general, most analysts feel the Ninth District will not be hard hit by defense cuts in coming years, mainly because the region's air bases appear to be safe from major cutbacks, and also because the district's diversified economy does not rely heavily on procurement contracts. Even if one of the bases were closed, they maintain, the negative impacts would likely be local in scope.

Regarding the supposed peace dividend, Thor Hertsgaard, professor of agricultural economics at North Dakota State University in Fargo, wryly suggests that the peace dividend for North Dakota will be that the state will not lose many defense contracts — with the implication that the state doesn't have much to lose. The same could probably be said for much of the Ninth District. In addition to allowing for a healthy adjustment period, Morrison feels the government should go one step further and consider the local conditions of the regions its decisions will affect. "A one-size- fits-all federal policy will represent too much federal response in some communities and too little in others," according to Morrison. "Differences in the rate of business formation and in the relative demand for workers with defense employees' skills in various communities also should be factored in."

Aside from emphasizing the need for strong local leadership in matters relating to economic readjustment, Morrison also details two ways the federal government can aid those efforts: to disseminate information on successful programs in other communities; and to provide employment assistance as a "backstopper" for communities and states that can't handle the dislocations.

Referring to Congress' tendency toward "ad hoc-ery" on issues, Malin of the Conference Board warned that legislators may be tempted to speed up the pace of defense cuts and eventually overreact. "We're not out of the defense business," he said. "You can carry that too far. Defense is a lot like infrastructure—it erodes and erodes and erodes, then you find yourself needing to rebuild."