If the government cuts projected growth in the portion of the defense budget devoted to developing and purchasing new weapons and equipment, it will be investing too little in future defense capabilities. This general conclusion is what Congress needs to focus on as it turns to defense acquisition reform. Cutting the modernization budget, something encouraged by Congress's current narrow approach to reform, could actually exacerbate the acquisition system's biggest problems-high unit costs for weapons and equipment and diminished competition in the defense industry due to consolidation. Rather, Congress should increase the modernization budget, which will help reduce unit costs for expensive systems and boost competition among defense contractors.

The Problem: Reduced Budgets for Modernization

Nobody doubts that there are systemic problems with the way the Department of Defense buys weapons and equipment. Congress is dissatisfied.[1] Department of Defense officials are dissatisfied.[2] Industry is dissatisfied.[3] While the problems with the defense acquisition system are numerous, it is important to separate the broad and systemic problems from the narrow and symptomatic ones.

There are two broad problems with defense acquisition at the present time. The first is high unit costs for weapons, particularly the major systems. For example, the Space-Based Infrared System-High (SBIRS-High), which is the next generation of early warning and tracking satellites, has exceeded cost projections multiple times in recent years. The second problem is extensive concentration in the defense sector, particularly at the prime contractor level. The defense sector saw a raft of mergers and acquisitions during the 1990s.

The common source of these problems was the "procurement holiday" taken during the 1990s. By 1997, the overall modernization budget fell by over 50 percent in real terms from the 1985 level (see Chart 1). The procurement budget in particular fell by roughly 65 percent. While there has been some recovery in the modernization budget (the sum of the budgets for researching and developing new weapons and equipment and for procuring them) since 1997, it has been only partial. Meanwhile, the portions of the defense budget devoted to military pay and operations and maintenance (commonly called the "operations and support budget") have enjoyed a full recovery. The modernization budget consumed slightly less than half of the total defense budget in 1985, but today modernization receives only about a third of the defense budget (see Chart 2).

Given this history, it is not surprising that unit costs have risen. In 1985, the Department of Defense purchased 585 aircraft, 2,031 combat vehicles, 24 ships, and 32,714 missiles.[4] Currently, defense production is at 188 aircraft, 190 combat vehicles, eight ships, and 5,072 missiles.[5] These low rates of production deprive the defense industry of the economies of scale it leveraged in the 1980s.

The same history has driven the industry to consolidate, primarily through mergers and acquisitions. In 1985, there were 20 prime defense contractors with broad expertise in defense systems.[6] Today, there are just six.[7] In the 1990s, it became a losing proposition for a prime defense contractor to carry excess production capacity. The rational alternative was to merge and strip away excess capacity in the process. This left the Department of Defense with a less competitive supply network, but the alternative was to allow a rash of bankruptcies and liquidations in the contractor base and an equally less competitive network.

Reform Is No Excuse for Cuts in the Modernization Budget

By focusing on narrow aspects of the problems with the defense acquisition system, some in the Bush Administration and, more particularly, in Congress run the risk of reaching the wrong conclusion. For example, it is easy to argue that each DD(X) destroyer is too costly and that the proper response is to punish the contractors by cutting funding for the program. Combined with similar conclusions about other programs, the result is a ready-made argument to cut the modernization budget as a whole.

That decision, however, will exacerbate, not remediate, the problems of increasing unit costs and supplier consolidation. Cutting the modernization budget would be an even more damaging replay of the 1990s, as the number of systems built shrinks still further and more suppliers merge. This was the point made by the Chairman of an internal Department of Defense panel that reviewed the options for reforming the defense acquisition system. Lt. General Ron Kadish, USAF (Ret.), stated in announcing the summary findings of his panel:

I would like to make sure that people understand we're not at all suggesting that if you take these recommendations, you can take X billions of dollars out of the budget. If that occurs, we have failed in reducing instability because that's more of the same.[8]

As well, by compounding the existing problems in defense acquisition, a decision to cut modernization spending will deprive the military services of the weapons and equipment they will need to remain the best-armed force in the world. If an argument can be made that defense spending is now too high-which should be an untenable argument for a nation at war-then the belt-tightening should take place in the operations and support budgets. This category of spending now accounts for more than 60 percent of the total defense budget.

Increase Modernization Funding

Six members of the Senate, led by Senators Jim Talent (R-MO) and John Warner (R-VA), propose a better approach. In a recent letter to President Bush, they urge the Administration to maintain the planned modernization budget of $158.3 billion for fiscal year 2007.[9] The letter, however, does not look beyond fiscal year 2007. Ultimately, Congress should look to adopt a general goal of $200 billion (in current dollars) for the modernization budget by the middle of the next decade.

This sustained approach should remedy the two most pressing problems in defense acquisition today. The increased budget would allow the purchase of larger numbers of each model of weapon and equipment. Over time, this should slow the growth in unit costs. Sustained growth in the modernization budget could also encourage firms currently outside the defense market to enter. This increase in competition and diversity in the supplier network should result in a more responsive, flexible, and efficient defense industrial base.

Conclusion

Congress faces a choice between two general approaches to addressing problems in defense acquisition. It could opt to address each shortcoming in the acquisition system individually and fashion numerous narrowly drawn remedies. The problem with this approach is that it is biased in the direction of reducing funding for individual programs and, cumulatively, the modernization budget as a whole. This approach is also self-defeating because it fails to account for recent reductions in modernization funding and their negative impact on the defense acquisition system.

The better approach is to understand the negative impact of earlier modernization funding cuts and improve the defense acquisition system by restoring funding in this area. While this approach will not solve all the existing problems with the defense acquisition system, it will help to ameliorate the broadest and most pressing ones.

Baker Spring is F.M. Kirby Research Fellow in National Security Policy in the Kathryn and Shelby Cullom Davis Institute for International Studies at The Heritage Foundation.