360 I June 19, 1984 1 REMOVING THE PENTAGON'S PERVERSE BUDGET INCENTIVES INTRODUCTION More effective use of its resources is rarely the result of today's U.S. military budgeting process. If a department improves it s effectiveness, it is often rewarded with a budget cut. If an ineffective program is eliminated, the result is a budget reduc tion rather than the opportunity to reallocate the funds to a promising alternative. Given such perverse incentives, reform in a ny area-weapons procurement, tactics, manpower training-is impossible.

This state of affairs is the result of the current item-by item, line-by-line budget process, in which each piece of equip ment and every spare part are authorized and appropriated for individually. High-level officials, including Members of Congress have to review thousands of details in order to make budget de cisions a method that thereby flaws many of those decisions If military budgets were to be submitted in broader aggre gations, decisions at the high level would be more goal directed and the military departments themselves would have greater freedom to allocate funds with.in the larger aggregations to their most effective use. Such changes would create powerful incentives for mil itary budgeting MILITARY MANAGEMENT Managing a defense structure entails two major activities.

The first is administration and resource allocation-the creation of combat forces like armored divisions, air wings, and fleets and the training of crews and tro ops to maintain and operate them. Such management is carried out by the statutory military departments--Army, Navy, and Air Force. The second activity is I 2 command of these forces in the field, a function of the unified and specified commanders. The Dep artment of Defense was created after World War I1 with authority over both of these activities.

Centralization In this examination of the administrative and resource allocation activities of military management, it must be noted that the most significant c haracteristic of the Defense Depart- ment is a highly centralized management plan. This takes two forms. First, the centralized Defense agencies have assumed a number of functions that each military department used to perform for itself, such as intellige n ce, auditing, mapping, and logis tics. Critics had found, for example, that the Army paid less for a specific item than the Navy. This suggested that there was Ifwastell and seemed to argue for a single agency to buy the item for all services. The problem with this reasoning is the assump- tion that the centralized agency can buy everything at the lowest price. In fact, a single agency is more likely to pay a higher price, because there is no immediate basis for the kind of com- parisons available to more i mmediate overseers and hence less incentive to manage diligently The second and more dangerous form of this centralized management is the ever increasing involvement of the Office of the Secretary of Defense, the Service Secretariats, and the military hea d quarters in every aspect of management and opera- tions. Field agencies and commands have lost much of their authority, and have been largely reduced to the role of providing information for headquarters I staffs As more information pours into the headqua r ters, greater emphasis is placed on Ilcoordinationll between the different staff sections, which often leads to watering down or filtering the information. Not only do traditional staff sections grow, but new ones are created, such as those for systems an a lysis or operations research, partly to reconcile theaoften inconsistent information that competing staffs and staff sections fed superiors A major casualty of this process is the quality of the information. Advocates in the process know that decisions ma d e in headquarters are influenced if not determined by the information sent in. Accordingly, information received by superiors in senior headquarters (and presented to congressional committees) is tailored to serve the budgetary and political objectives of the agency producing the information: decision makers seem to realize the extent to which the informa- tion they use is either manipulated or produced to obfuscate rather than illuminate Few senior For recent examples of such an evaluation in activities l ike personnel training and medical affairs, see the accounts described in Archie D.

Barrett, Reappraising Defense Organization (Washington, D.C National Defense University, 1983), pp. 191-239 3 Weapons Procurement Among the major criticisms of weapon progr ams are their large cost overruns, failure to meet performance specifications, and slippages in time availability. Just as serious, the current generation of weapons is so costly to maintain and operate that the opportunity to train troops and crews--allo w ing them to fly and shoot new equipment--is constrained. effects on morale and personnel retention. Moreover, the combat effectiveness of many weapons is unknown, mainly because opera- tional testing of weapons and tactical doctrine is inadequate.2 tivene s s is one of the principal reasons that weapons acquisition often seems out of control. Performance requirements are limited primarily by what seems feasible within the state of the tech- nical arts and not by the anticipated use of the weapons. The specif i cations for technical performance requixements are too often driven by the motive to win funding approval (and advocacy Because there is so little rigorous operational testing of per formance characteristics; the preferences of technicians rather than use r s dominate the weapons development process A This has had adverse The lack of knowledge about tactical and operational effec THE BUDGETING PROCESS AND THE INCENTIVES IT CREATES The driving force of the military budgeting process is advocacy. Military serv i ces try to maximize their budget Given a changing technology that may upset the status quo between the various specialized military functions, each service presses to obtain development funds for new weapons that will fortify its future role. Weapons also justify units--divisions, wings, and fleets--and thus provide a rationale as well for funding manpower resources In the post-World War I1 period, there have been two major .approaches to the budgeting problem. Prior to the arrival of Robert McNamara as Se c retary of Defense in 1961, each military service was restricted in total dollars and manpower, but each had much freedom to interpret foreign policy and to decide what was the most important military threat and how to meet it. Critics argued that this cau s ed the individual: services to place an undue proportion of their resources in some areas, while giving less attention to others, resulting in an unbalanced total force structure This service rivalry over budgets was not all.bad. It led to some worthwhile developments, as illustrated by the Polaris submarine-launched missile. The Navy won out over strong Air See J. A. Stockfisch, Plowshares into Swords: Managing the American Defense Establishment (New York: Mason and Lipscomb, 1973 4 Force opposition. Toda y , with the growing vulnerability of land-based missiles, few would fault this third leg of the U.S strategic triad. But critics nevertheless argued that there was unnecessary duplication of weapons development. the alleged proliferation of weapons develop m ent, the power of the Secretary of Defense was increased in the 1958 Defense Reor- ganization Act. tary services and their respective combat specialties remained unchanged. New weapons justified and maintained a service's llsharell of R&D resources and re i nforced a service's claim to both a military mission and an overall budget. necessary to fight the budget wars as to fight real wars and equip troops To try to control But even so, the basic incentives of the mili New weapons became as McNamara sought to e liminate the imbalances resulting from interservice rivalry, and in fact, eliminated many of the major ones A management instrument he used was to identify and cost out major mission categories such as strategic, conventional, and mobility forces, and ele ments within these major groupings. But he gave the military departments no broad budgetary guidance. Rather he asked the military departments, operating through the.

Joint Chiefs of Staff (JCS to present their recommendations on how to meet the threat. fo rce recommendations which, when costed out, exceeded the Secre- tary's (and Administration's) view of requirements by around 30 percent, and the JCS had no ability to force a resolution. The Secretary then "cut back" on the services' recommendations, not i n terms of total dollars but in terms of specific force struc- ture elements and weapons acquisition programs. The systems analysis process McNamara introduced into the Pentagon used cost effectiveness techniques to aid, and then support, the Secretary's decisions. In this fashion, fine-tuned decisions on,force struc- ture and equipment were made and then forcefully advocated before congressional committees.

The dialogue between the Office of the Secretary of Defense OSD) and the military services was cond ucted in terms of cost effectiveness analysis terminology, but neither cost nor effec tiveness was held constant by the Secretary or OSD some programs would be cut back on cost considerations, others because of effectiveness. This lack of consistent crite r ia was especially frustrating and dangerous for service advocates. On many occasions strong service claims about the alleged effective ness of a program were turned around to justify budget cuts If this system is so effective, then we don't need as many o f them Hence the services became very careful about the kind of informa- tion they transmitted to the civilian leadership. This also explains why the services today have so little incentive to do rigorous operational testing: the results of such tests coul d be used by both Pentagon officials and Congress to justify budget cuts The services consistently presented That is Although centralized decision making has increased in the Defense Department with the passage of time, it has long been a 5 feature of U.S. defense management. Congress almost always has been concerned with decisions on how money is spent, or reviewing and approving the many details of administration In the past, Congress was usually more interested in Ilwherell the money was spent, such as t h e shipyards in which repairs would .be made and the location of garrisons, than on what it was spent for. In terms of broad categories of spending, however, Congress has been more generous toward procurement than toward such oper- ating expenses as traini n g and exercises. As a result, tactical and operational skills had to be acquired during the early phases of a war (often at the cost of excessive casualties). In this setting, the military services--or more accurately the chiefs of military technical bure a us--catered to congressional interests and adapted military management to that traditi~n.~ Secretaries of War and Navy were involved in the same game frequently enough to have inspired the humorist, Mr. Dooley, to remark that "the first qualification of a Secretary of the Navy was that he should never have .seen salt water outside of a pork barrel INFORMATION AND BUDGETARY .INCENTIVES To the extent that it is a motivation of a government agency 6r bureau to maximize its budget, system cannot help but be in f luenced by this in~entive budget has to be justified in a detailed way, whereby the total its information and reporting If the For those not familiar with military lexicon "Technical Services" and Bureaus" refer to the specialized sub-elements of the old Army and Navy like the Army's Ordnance Corps, the Navy's Bureau of Ships, and so on.

In the pre-World War I1 period, these agencies were powerful fiefdoms which operated arsenals and shipyards, and were seldom "controlled" by anyone, including service chie fs, Secretaries of War or Navy, or even the President. They dominated weapon selection and procurement with mixed results within a year of its outbreak if the Army's Ordnance Corps had promptly moved to acquire Henry and Spencer repeating rifles. But the Chief of Ordnance, General Ripley, adhered to the idea that muzzle loaders were good enough.

Lincoln caused the Army to buy enough Spencer repeaters to equip Union cavalry late in the war these weapons, and did not get a magazine rifle until some thirty ye ars later Many similar experiences during World War I1 and afterward sup ported the notion that civilians should dominate weapons development and procurement.

It is the.contention here that it is a motivation of bureau professionals to try to maximize the ir budgets. This is not to assert that it is their sole motivation. The assumption can be derived from the point that bud gets are necessary to enable bureaucrats to "do their thing"--to defend the country, educate the young, and thereby serve the "public interest."

Budgets are also proxies or and a source of power For example, the Civil War could have been won by the Union Only the personal and active intervention by President After the war the Army promptly got rid of '3 is the sum of many items, each of which is scrutinized and ap- proved by the higher authority, then the inforination on each of these items will be influenced by the budgetary incentive. Hence, subordinate agencies have incentives to provide only the most favorable information or even to fabricate information.

Mani pulation of data is widespread by bureaucratic organi- zations and achievable by a variety of techniques. organizations have exaggerated the capability of.opponents and understated that of friends ally's combat organizations and to compare this number wit h the opponent's total equipment procurement, which would include items in repair depots, those used for training, and stocks procured for combat consumption allowances.5 On one occasion the Senate Armed Services Committee noted that the U.S. Army's statem e nt of rifle assets and requirements behaved in strange ways; the amount required decreased as the size of the Army increased during the early period of the Vietnam buildup.6 that the Army wanted to minimize its purchase of M16 rifles which it did not deve lop, while it tried to develop (on a crash basis a newer and more exotic weapon.

The same sort of incentive prompts organizations to avoid gathering information. This is why so little operational testing is done. This problem springs from characteristics o f testing er se. A test might show that a favored doctrine or weapon knot be as good as had been claimed. If prior decisions were made, involving either large amounts of resources or the personal prestige of decision makers or staff advocates, the results of the experiment could be embarrassing-even politically damaging. Those likely to be hurt might be professional military officers, civilian policy makers, prominent scientists who have Ilstakedl' their professional reputation on a particular approach OX C ongressmen concerned about defense contracts for their districts So long as this relationship between information and budgetary incentives continues and its impact on weapons system specification and force structure design prevails, managing the Defense D e partment will remain problematical. Clearly, information and analysis will not be improved unless the incentives are changed. Better decisions cannot be made unless better information is available. Management changes, such as reorganizations, the strength e ning (or weakening) of offices or staffs, the introduction of different Military One way to do this is to count the I equipment (e.g tanks or aircraft) only of the friend's or The reason for this was c For an'account of one such example relating to the Ro y al Air Force's estimates of the German air order of battle, after the Battle of Britain see R. F. Harrod, The Prof (London: Macmillan, 1959 pp. 3-5 See Hearings before the Preparedness Investigating Subcommittee, Commit tee on Armed Services, United State s Senate, 90th Congress, First Session Army Rifle Procurement and Distribution Program (Washington, D.C U.S Government Printing Office, 1967). 7 reporting systems (the standard stuff of management experts'and specialists) hardly come to grips with the real problems. Indeed these traditional I1cures1l often worsen things A more fruitful approach would be to find ways to harness the bureaucratic in centives constructively and to minimize the effects of negative 1 L incentives CHANGING THE INCENTIVES BY CHANGI NG THE BUDGETING PROCESS Although it is true that Defense Department management has become too centralized, the real problem is that political deci sion makers make too many decisions with inadequate information.

The budgeting process works to prevent them from acquiring, or using, the right kind of information from the military. This would continue even if, for example, the power of the Office of the Secretary of Defense were drastically reduced, but the re quirement continued to justify budgets in the sa me highly detailed way to congressional committees.

Improvement of defense management to achieve greater effi ciency and military effectiveness is not feasible unless the quality of information can be improved. This is impossible unless those who are most knowledgeable about specialized mili tary combat roles have strong incentives to engage in detached study of their specialities. But when dollars are at stake, the quest for knowledge will not be critical or detached.

Creating the proper incentives requir es that the service budgets be presented and acted on in larger aggregations by-item budgets must give way to budget categories that reflect an aggregation of related items. Conversely, the military should be given greater freedom to control and reallocat e within those aggregations. These major budget aggregations should be deter mined by high-level civilian officials (in both the Executive and Congressional branches). Ways should be sought to minimize the involvement of the military in these high-level bu d getary con siderations. Rather, the expertise of the military professionals should be used to create as much combat capability as possible for the resources provided to them by the civilians Item For example, it might be decided that 20 active land force d ivisions are needed to meet U.S. commitments. These might cost including a share of the R&D budget 100 billion a year. This dollar figure could be regarded as a I1baselinelt budget for the broadly defined military mission described as Itland war." This am o unt (adjusted over time for inflation) should only be changed by the most senior civilian authorities on the basis of broad foreign policy changes, revised threat assessment, or major fiscal policy considerations. Initially, if there were three Marine Cor p s di.visions and seventeen Army divisions 15 billion of the $100 billion mission budget could be allocated to the Marine Corps, and the remaining $85 billion to the Army. It could further be made known to both of these services that if onea of them were a b le to squeeze m0r.e combat effectiveness out of its budget than the other, some future budget reallocation in favor of the more efficient service might be made. would harness interservice rivalry in a constructive way. Such an approach This would require t hat the civilian authorities have the means to evaluate and judge the potential combat efficiency of the competing services. For this purpose, emphasis should be placed on readiness evaluation (including unannounced drills) that emphasize unit tactical an d operational skills. Shooting, target location and identification, performance of reconnaissance missions, ability to carry out tactical and strategic deployments with limited advance notice, capability to sustain operational activity-all these and other t actical and operational support functions can be tested,and measured in imaginative ways relative to available resources. With such measures, civilian political authorities and unified operating commanders periodically could evaluate the outputs of the mi litary departments, adopt a role similar to that of a consumer in the marketplace, and discard the present role of attempting to infer capability by examination of detailed budget information.

If budget aggregations were provided for mission categories, th e military user would be put on notice that if he bought a costly weapon, he would have to give something up. Conversely, if he developed more efficient ways of maintaining equipment, the money saved could be used to buy something else. Such a system woul d introduce a strong incentive to eliminate marginal or redundant items. centive for military users to raise questions and acquire infor- mation about which items were redundant. should extend to costly, incremental technical performance features of propos e d new systems current connection between the total dollars received for-equip- ment and the specific items procured so that the decision to buy or not to buy a particular item will not affect the budget allo- cated to a given mission or military combat sp e cialty. Under the present system claims are made for development programs because they provide a justification for funding. Support of such claims by rigorous tests, often possible by field experimentation, is seldom attempted. Under the suggested approac h , a service would find that its own best interests would be served by thorough operational testing. In such a setting, the service would acquire equipment to achieve effectiveness, rather than to obtain dollars To allow the services greater latitude to ma k e choices, however, presents a potential problem that the wrong choices might be made to the detriment of force readiness and sustained combat operations. Needless to say, choices like these have a high foreign policy content. Combat ready forces (and the ir More important it would create a strong in The same skepticism The aim is to reduce greatly, if not to eliminate, the wartime stocks however, must be maintained. Defense author- ities must see that this wider latitude does not undermine readiness.

The g eneral management philosophy implicit in the above is twofold First, the military departments and their major combat specialties should have maximum opportunity and incentive to try to get as much combat capability as possible from the resources budgeted t o them. They must be able to make tradeoffs among the diverse, highly specific resources currently identified as budg- etary line-items. To make these tradeoffs, they must economize on some items, butthey must also be allowed to spend savings in other way s that contribute to combat effectiveness. This is simply another way of saying that military specialists should have more freedom than they now have to allocate (and reallocate) resources decision making through budgetary channels on the part of Congress a nd the Office of the Secretary of Defense and policy constraints. authorities. The civilian authorities must allocate the budget in terms of major missions and statutory military departments. Moreover, they must specify combat readiness and sustainability in ways consistent with national security objectives and coordi- nated among the various combat specialties, including land, air, naval, and strategic deployment forces political authorities resist trying to manage in detail through budget channels and at t empt to create more productive incentives, which would both encourage and allow the military professionals to manage resources effectively This is also an argument for much less detailed Second, the military .departments must operate under resource These m ust be set by the highest civilian The underlying philosophy of this proposal is one whereby e a This subject, of course, has many dimensions: the role of reserves mobilization planning, consistency among diverse combat and service element (e.g., land, ta c tical air, and strategic lift), foreign basing arrangements with possible allies, and finally, criteria by which readi ness of combat units may itself be specified and measured. Readiness criteria are unduly specific in terms of such input concepts as per c entage of authorized troops or materiel present in the unit. As an alternative emphasis should be placed on measures that are closer to military output such as how quickly and well can a unit deploy and perform simulated missions. Apart from giving troops and crews desirable exercise and training, readiness evaluation exercises keyed to appropriate output measures would also provide much valuable information about equipment and manning requirements and about the management skills of individual com manders. But, again, strong incentives to generate this kind of informa tion are lacking under the present budgeting and planning system e C 10 CONCLUSION Congress should aggregate its Defense appropriations along mission or service lines. The services, in turn, s h ould be allowed to reprogram the funds within these categories to attain maximum efficiency. The current item-by-item budgeting creates the wrong incentives and a sense that the budget must be protected at any cost. Killing a marginal program results in l o st budget dollars and no assurance (or even reasonable expectation) that those dollars can be spent on an alternative. Aggregate budget- ing with reprogramming authority would create the proper incen- tive: to maximize effectiveness. Congress, of course, would retain.the control it needs to implement a policy aim.

It could, for example, preclude development'of a certain kind of weapon simply by prohibiting expenditures for such weapons. Fine- grained budgeting and management by Congress=-and perforce by th e Pentagon--has proved counterproductive. Aggregate budgeting offers a solution that would not only improve military effective- ness but might even allow the Congress to pass a defense appro- priations bill on time Prepared for The Heritage Foundation by J. A. Stockfisch 0 7: J.A. Stockfisch is Senior Economist with the American Petroleum Institute Washington, D.C. He is the author of Plowshares into Swords: Managinq the American Defense Establishment, a study of military procurement