Procurement: Fun With Numbers

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August 26, 2019: One of the minor miracles of military procurement was the unexpected ability of the F-35 manufacturer to halt the growth in F-35 production costs and then actually reduce the cost per aircraft. This was done by providing large incentives to succeed as well as large penalties for failure to curb cost growth. Put simply the new arrangement lets the manufacturer keep half of every million dollars in reduced cost, with the rest going to the government. But if costs increase the manufacturer absorbs half of it, and all of it if costs grow by more than 20 percent. This is being done for each annual F-35 order, allowing for adjustments, as needed, to the arrangement. Already the price-per-aircraft is gone down from $89 million to $81 million per aircraft and is expected to fall below $80 million per aircraft by 2020.

On the face of it this seems to be a perverse incentive system and anywhere but in defense spending, it would be. Yet defense procurement, especially in peacetime, has always been perverse and has become more and more perverse since the 1950s when outgoing U.S. president Dwight Eisenhower warned of just such problems.

Military procurement in the United States has been a mess for decades and efforts to fix the problems consistently fail. In fact, the many “fixes” implemented have become a problem. It has reached the point where there are so many people involved in decision making that no one running these procurement projects is really in charge. The only ones really content to let this go on as it is are the manufacturers, who always get paid and have plenty of bureaucrats to blame for anything that goes wrong. Then there are the politicians, who are rewarded with lots of project related jobs for their constituents, which helps with getting reelected. The troops and the taxpayers get screwed and no one has been able to find a workable solution yet. There have been interim fixes that work for a while, like the F-35 cost reduction incentive program. But these fixes tend to eventually come off the rails because of the way the system is.

This became obvious when, back in 2014, an analysis showed that over fifty major defense projects were several hundred billion dollars over budget and, on average, nearly two years late. Analysts identified some basic problems. For example over a third of the cost overruns are the result of suppliers submitting unrealistically low bids for new weapons, and then coming back for more and more money as "unforeseen problems" appear and costs kept escalating and delivery delayed. This has come to be called "lowballing." The military goes along with lowballing because it makes it easier to get Congress to approve the projects. Once a new project is in the military budget for a few years, it is very difficult to get it canceled. Since Congress has a short memory, the military does not take much heat for this never-ending "lowball" planning process. Several major efforts to eliminate lowballing have failed. Too many people involved benefit from lowballing. The troops and taxpayers get screwed.

Actually, it's poor planning in general that causes most of the high costs. It's bad planning by the military when coming up with the initial design and bad planning on the part of the few manufacturers that have a monopoly on building certain types of weapons systems. Monopolies do not encourage efficiency. There are many examples of all these bad habits at work. Don't expect any of this to change anytime soon. It's the way things have worked for a long time. Many generals and admirals, members of Congress, and even a few manufacturer executives have called for reform. But it just doesn't happen, at least not to a large extent.

One encouraging post-Cold War trend has been an increased reluctance to build a lot of a weapon that became extremely expensive because of the malignant procurement process. Thus the B-2 bomber, Seawolf submarine, F-22 fighter, Crusader artillery system, Comanche helicopter, and DDG-1000 destroyer all got production cut sharply or were canceled when their budgets went too far out of control. So there's hope yet.

Another problem is that military spending has, over the last 50 years, continually declined as a percentage of GDP. Thus while ten years of war against Islamic terrorism, especially in Iraq and Afghanistan, cost about $1.5 trillion, that's not as big a chunk of change as it used to be. For example, World War II cost, at the time (in current dollars) over four trillion dollars. That amounted to over 33 percent of U.S. GDP at the time. The current war on terror is costing about one percent of GDP. So while war may appear to be getting more expensive, relative to the amount of money available, it's actually getting cheaper. Unfortunately, the politicians who approve budgets and the defense manufacturers to build stuff have figured that much out as well.

As a percentage of GDP, military spending continues a decline that has been going on since the 1960s. Back then because of the $713 billion cost of the Vietnam War, defense spending was 10.7 percent of GDP. That went down to 5.9 percent of GDP in the 1970s and, despite a much heralded defense buildup in the 1980s, still declined to 5.8 percent. With the end of the Cold War, spending dropped sharply again in the 1990s, to 4.1 percent. For the first two decades of the 21st century, defense spending is expected to average less than 4.5 percent of GDP. Most of the current defense budget is being spent on personnel (payroll and benefits) and buying new equipment to replace the Cold War era stuff that is wearing out and to pay for operations in Iraq and Afghanistan.

This trend is all because of the industrial revolution that got doing in a big way during the 19th century. This created a lot more wealth to tax and that made it possible for many nations to do things not possible before, like squander lots of this new wealth on wars they could not have afforded earlier. The American Revolution, for example, cost the United States less than $2 billion. The main reason for the low cost, compared to later wars, was that there simply was not a lot of wealth (money or goods) to scrounge up for the war. Britain spent far more and the political blowback from that led to Britain eventually giving up.

The United States has always been enthusiastic about spending enormous amounts on weapons, ammunition, supplies and equipment for the troops, with the idea of keeping U.S. casualties down while still winning the war. Thus during World War II, U.S. combat deaths were 300,000 (plus 100,000 non-combat dead). The Soviet Union, on the other end of this scale, lost 10.7 million dead in combat (including 4.4 million captured and missing), and nearly 20 million civilians killed as well. Of all the major combatants in World War II, the U.S. had the lowest armed forces casualty rate (about 2 percent). Russia lost about 15 percent of its entire population during the war (compared to less than half a percent for the U.S.). For every American killed during World War II, Russian lost 75.

The U.S. kept its losses down partly because of the amount of money spent per person in the military (over $250,000). Since September 11, 2001 the casualty (death) rate is a third of what it was during World War II, and the amount spent per person has more than tripled. Exact comparison is tricky, as all military expenses were counted during World War II, while the current war is being fought with only a small portion of American military might, and the navy and air force continue to take care of many non-war-on-terror responsibilities. While the dollar cost of war is good for a hot headline on a slow news day, the fact that the money saved lots of American lives, never seems to make it to the front page.

However, there are other expenses that are rarely mentioned. The initial cost of World War II, and most wars that came after it will eventually double because of the cost of taking care of the veterans. There were over a million casualties in World War II, many of them serious and with long-range effects. The long-range health problems were not anticipated, nor were the more expensive treatments. You have to pay. The vets are owed a debt that cannot be avoided.

 


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