On Defense Spending and Price Gouging

 It is inevitable that another article will soon appear comparing the price the Department of Defense pays for a simple object on a weapons system with the price a supposedly similar object costs at a local hardware store.  A quick glance suggests that the military, and we taxpayers, are being price gouged by greedy corporations.  While there is certainly the opportunity for such to occur, we are rarely provided anything more than a hasty glance at the situation.  We should realize that components that are sufficient for typical commercial or residential activities are not necessarily capable of performing as reliably as necessary in a high-priced critical asset in a time of war.  A $5 valve from Home Depot is not likely to be found on a multimillion-dollar jet experiencing huge temperature and pressure variations and high-G maneuvers, while having failure probabilities of less than a part per billion.  And if one is in a system where the price of an entity is expected to be equal to the cost of the components, strange numbers will appear.  Consider any bill for a stay in a hospital.

It can be extremely misleading to compare what happens in a competitive consumer market with what happens in the limited marketplace that the military has created for itself.

Consider what happened when the military got into the nuclear weapons business.  The development of nuclear explosives technology was the task of the Manhattan Project at Los Alamos in New Mexico.  Los Alamos would function as a national laboratory under civilian control in the postwar period and be assigned to provide designs of nuclear explosives that could be weaponized for nuclear war scenarios.  It quickly became clear that nuclear explosives were going to be assigned more complex performance requirements and more severe safety and security demands.  The military was operating in a business where market competition was impossible.  They had only one source for what they needed, and they were headed in a direction where the technology at hand was getting more complicated.   They decided they needed to provide a kind of market-like competition by creating a competitive counterpart to Los Alamos.  That would become the Lawrence Livermore National Laboratory (LLNL) which was formed in 1952.

So, the military now had two captive sources for what it needed, and in creating them as competitors, they made sure that each Laboratory would try to outdo the other.  This approach provided the military with new and improved designs in terms of performance, safety, and security.  However, it nearly doubled the cost of servicing military needs by maintaining duplicate arrays of scientific and engineering experts and their needed resources.  It is important to recognize that these Laboratories did not just provide what the military asked for.  They also possessed people who both understood the military’s needs as well as what technology could provide.  A good defense contractor will tell the military when technology can provide it more than they knew to ask for.  To provide that kind of support, the Laboratories, or other defense contractors, must be able to perform internal research and development that may or may not lead to any application.

It has been a long time since a new nuclear warhead has been required.  Yet the technology and infrastructure to do that has been maintained at almost the same level.  The focus has shifted from production to maintenance.  Nuclear warheads age like any other complex construct.  The delivery systems for nuclear warheads also age and must be replaced.  A new delivery system can impose new constraints or new environments in which the warhead must perform as intended.  New types of warheads may never be needed but replacement copies of existing warheads might be required.  The capability to make that call and produce the equivalent product must be maintained indefinitely.  Continuing that funding via the national laboratory system has not been a problem for such a unique capability.

The postwar market for conventional, nonnuclear, projects was much different.  There were many commercial firms involved in defense work.  Perhaps, too many.  As the major acquisition targets became more complicated, the demands on the defense contractors increased and the number with the resources to compete diminished.  In addition, those that remained always had the option of focusing on more general commercial projects, where the economic reward might be greater.  At some point, the Pentagon seems to have decided that its needs could be better met with fewer, but bigger contractors.  The ideal situation would be a number of captured corporations for which the Department of Defense could provide enough work to keep all fed and motivated to continue to focus on the technologies required for the ever-more-complex weapon systems being sought.  This defense market would contract, mostly though mergers, to five major contractors.  Whether this number was by design or happenstance is not clear.  This source provides the major defense contractors as of 2021. 

Lockheed Martin Corp.; Obligations: $40.2B 

Boeing Co.; Obligations: $22.1B

Raytheon Technologies Corp.; Obligations: $20.7B

General Dynamics Corp.; Obligations: $17.8B

Pfizer Inc.; Obligations: $13.3B

Northrop Grumman Corp.; Obligations: $12.9B

Pfizer is only here because of the DoD participation in vaccine acquisition and distribution during the recent pandemic.  General Dynamics is the only one of the other five that was not formed from the merger of similarly large defense contractors.

There are a number of potential difficulties, or failure modes, with such a marketplace.  The foremost is the relationship between buyers and sellers.  In a volume-driven market where well-defined products are needed the buyer is in a strong position to control price and quality.  When the market is technology-driven, much of the leverage resides with sellers often promising they can do something that has not been done before.  Whereas the captive contractors in the nuclear warhead community are essentially government employees, those working on conventional systems belong to profit-making corporations whose incentive is not to make inexpensive items, just items less expensive than those of a few competitors.  In fact, there is an implied agreement that the military will provide enough revenue to keep the captive contractors healthy financially as well as technically.  This can lead to allocating resources in such a way as to balance workload rather than reward the best proposal.  The experts best able to evaluate the technical feasibility of project proposals often reside in the contractor community, and military personnel are aware that cushy jobs are available in the contractor community after they leave the service.  Cost-limiting disincentives abound.

The manner in which new projects lead to inevitable product delays and cost overruns suggests that the defense contractors have too much leverage in the system.  It is not a perfect way to acquire military products, but it could be worse.  Consider the current state of Russia’s once vaunted military machine.  A bit of waste in procurement is better than the massive theft of a kleptocracy.