THE DEFENSE LANDSCAPE

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1 THE DEFENSE LANDSCAPE Merrick Mac Carey CEO, Lexington Institute Defense Credit Union Council April 30, 2014

2 Threats Drive Defense Spending Defense Spending as % of GDP 50% 40% World War Two 30% 20% 10% Spanish- American War World War One Korean War Vietnam War 0% Imperialism Fascism Communism Terror Defense is the only sector of the U.S. economy where demand is driven mainly be external, non-economic forces. 1

3 Defense Macro-Driver: Threats The modern defense department was made possible by an unusually protracted, urgent threat -- the Cold War. -- Peer industrial competitor -- Technological rivalry -- Predictable behavior -- Consensus on danger Duration & Intensity of Threats Cold War Imperialism Fascism Communism Terrorism Today, there is no peer competitor, little predictability, and scant agreement on dangers -- signaling unstable future demand. 2

4 Has the U.S. Defense Spending Pattern Changed? Since 1960, the buying power of the Pentagon budget has varied within a well-defined range. ($2009) $600B Carter Clinton $300B Johnson Reagan Bush But in 2008, outlays broke out of the range on the upside, and hit nearly $700B per year. This reflected the temporary cost of fighting two wars at once, and more durable factors such as the rising cost of the All Volunteer Force. However, we have been reverting to a postwar norm due to receding threats, large deficits, and an ambitious domestic spending agenda. 3

5 Defense Spending in Constant FY 14 $ FY 15 Source: The Punaro Group 4

6 Defense Macro-Driver: Economy Since 1950, the world s biggest economy has generated whatever resources the Pentagon required, but that may be changing. -- Slow growth, federal debt, large welfare state. -- On average, the U.S. share of global output fell one percentage point every year U.S. Share of Global Output & Military Spending 41% 32% 33% 23% Economic Output Military Spending Economic Output Military Spending U.S. shares of global economic output & military outlays have drifted out of alignment. 5

7 Defense Macro-Driver: Federal Budget After four straight years of trillion-dollar deficits, the need for new federal borrowing has moderated. However, CBO projections reflecting recent tax increases and spending cuts still indicate a structural deficit. Average deficit 1974 to 2013 was 3.1% of GDP. 900 Annual Deficits $ Billions % of GDP 4.1% 2.8% 2.6% 2.8% 2.9% 3.0% 3.3% 3.5% Congressional Budget Office: April

8 Federal Debt Held By The Public 7

9 Total Federal Debt 2014 = $17.7 trillion 2024 = $27.1 trillion Interest Payments on Federal Debt 2014 $227 billion (1.3% of GDP) 2018 $491 billion 2024 $876 billion Congressional Budget Office: April

10 The Federal Debt: Interest Payments $ Billions Food Inspection 17.6 NASA Immigration and Customs Enforcement FDA Federal Highway Budget 10 Coast Guard Department of Veterans Affairs 8.3 FBI 2014 Federal Interest Payments 2018 interest payments on federal debt: $491 billion (Congressional Budget Office). 9

11 Recent FRB Balance Sheet Trends Total Assets of the Federal Reserve Source: Federal Reserve Board 10

12 Tea Party / GOP Response to Bush bailouts and Obama spending/debt. Fulcrum of House of Representatives power. Budget Control Act 2011 victory. Defense spending loses appeal to new GOP. Sequestration cliff: 1 March

13 Personnel: A Budgetary Time-Bomb The cost of military pay and benefits is increasing much faster than inflation. The after-inflation annual cost of each warfighter rose 45% in 12 years. Rising operations & maintenance costs are driven largely by people outlays. If defense spending levels off while people costs keep increasing, more weapons & technology will be squeezed out of the budget Average Annual Cost of One Warfighter $55,000 $160,

14 A Large Bureaucracy OSD, Joint Staff, Combatant Commands, Defense Agencies ,000 people, $116 billion Joint Staff increase from 2,000 to 3,000 in Obama first term as fighting forces were reduced. AT&L: OSD s Acquisition, Technology and Logistics directorate -- 46,000 people 20,000 pages of rules and regulations, many required by Congress Defense Commissary Agency: 10,000 civil servants 13

15 DoD Top Line Drawdowns Post Korea 43% Post Vietnam 31% Post Cold War 39% Post Terror War FY 15, $60 billion OCO placeholder 19% (so far) 14

16 Military Spending In Last Downturn (Billions of constant 2012 dollars) Functional Category Military Personnel Operations & Maintenance 1985 budget 1995 budget % change from budget % change from , ,485-25% 97,030-32% 163, ,513-15% 138,067-16% Procurement 203,378 64,841-68% 71,377-65% Research & 65,790 51,448-22% 50,505-23% Development Other (milcon, 27,421 18,155-34% 11,591-58% housing, etc.) Total 602, ,443-37% 368,570-39% Procurement fell much faster and farther than other functions. Military personnel decline reflected 30% cut in active-duty headcount , and 36% cut

17 DoD Military & Civilian Endstrength,

18 Budget Totals in President s FY 2015 Budget Request Source: Office of the Under Secretary of Defense (COMPTROLLER)/CFO Source: Office of the Under Secretary of Defense (COMPTROLLER)/CFO 17

19 Reduce Numbers of Personnel Source: Office of the Under Secretary of Defense (COMPTROLLER)/CFO 18

20 Goals for Forces and End Strength Source: Office of the Under Secretary of Defense (COMPTROLLER)/CFO Source: Office of the Under Secretary of Defense (COMPTROLLER)/CFO 19

21 Defense Spending / Contractor Support All Contractor Support Spending at defense department 250 $ Billions FY 2009 FY 2010 FY 2011 FY 2012 FY % drop from FY 09 to FY 13 Source: Professional Services Council 20

22 DoD Contractors in USCENTCOM AOR (U.S. Citizens) Feb ,540 May 10 53,421 Sep ,059 Dec ,524 Jan ,711 Apr ,650 Jul ,321 Oct ,928 Jan ,594 Oct ,892 Jan ,768 Apr ,324 Jul ,941 Oct ,383 Jan ,764 Feb ,302 39% decrease from Feb. 10 to Feb. 14 Source: Office of the Deputy Assistant Secretary of Defense 21

23 Post Terror War Drawdown Top Line 19% FY 15 Active Army 23% President s Budget FY 19 Active Army 26% Full Sequestration FY 19 Active Marine 10% President s Budget FY 19 Corps Active Marine 13% Full Sequestration FY 19 Corps DoD Civilians 5% President s Budget FY 19 Contractor 23% FY 13 Support SOCOM 16% FY 14 FY 15 22

24 Decade of the 2010s

25 The Biggest Threats Are Far From Home and expensive Europe: aging population, waning influence Russia: oil-dependent economy, resurgent empire Mexico: narco-terrorism, illegal migrants Latin America: rise of leftist dictators Africa: failed states, resource wars Middle East: 2/3 of world s oil, center of fundamentalist terrorism China: world s most dynamic economy fuels military expansion Asian Littoral: WMD technology spreading to Iran, Pakistan, India & N. Korea 24

26 Trends: National Security Threats 2014 Russia Terrorism WMD Proliferation China Aggressive reassertion on European stage Limited post-9/11 attacks on CONUS Three national efforts stopped, but concern about Iran, Pakistan, North Korea Large military buildup, but stable region 25

27 Russian Revanchism Belarus is a de facto vassal Russian state. 26

28 Middle East 27

29 Terror Plots Against U.S. Homeland 28

30 Petroleum and Natural Gas Production Source: Energy Information Administration 29

31 Southwest Asia 30

32 Northeast Asia 31

33 Southeast Asia 32