Biggest Defense Spending Dive Shows Risk of U.S. Cuts

The year-end plunge in U.S. defense spending may provide the industry with more ammunition to fight automatic budget cuts it says will harm the economy.

Defense purchases in the fourth quarter plummeted 22 percent, the Commerce Department said yesterday. It was the biggest decline since 1972, when military spending slumped as the Vietnam War ebbed, and it contributed to the economy shrinking at a 0.1 percent annual rate in the quarter.

The drop in defense expenditures may reflect the winding down of two wars and $487 billion in military reductions already planned over a decade. The automatic cuts would come on top of those reductions.

“Those politicians are all on notice now,” Eric DeMarco, chief executive officer of San Diego-based Kratos Defense & Security Solutions Inc., said in a phone interview. “If they don’t fix this, the country is going back into recession.”

The recent quarter’s figures “may be a harbinger of what’s to come” under the automatic cuts, said Dan Stohr, a spokesman for the Aerospace Industries Association, an Arlington, Virginia-based organization that represents contractors. The group has led efforts to prevent the cuts, saying the reductions would result in more than 1 million jobs lost.

The fourth quarter’s outlays don’t reflect a sharp contraction in annual defense spending. While defense outlays plunged 22 percent from the previous quarter on an annualized basis, spending for the year fell 3.1 percent from 2011, according to Benjamin Mandel, an economist at the Commerce Department’s Bureau of Economic Analysis.

Contracts Rush

Defense expenditures totaled $677.2 billion in inflation-adjusted dollars in 2012, compared with $699.1 billion in 2011, according to bureau figures.

If the automatic cuts aren’t averted by March 1, defense funds would decline 7.3 percent and nondefense federal programs would fall 5.3 percent, according a Bloomberg Government estimate.

The reductions would total $45 billion this year, according to the Pentagon.

The automatic cuts will take place unless the Obama administration and Congress work to stop them. It’s “more likely than unlikely” that the reductions will take effect, Deputy Defense Secretary Ashton Carter said on Jan. 29.

The fourth-quarter decline partly reflects a spike in defense spending in the previous three-month period, Kevin Brancato, an analyst at Bloomberg Government, said in a phone interview. The Pentagon traditionally spends the most in the third quarter, which marks the end of the government’s fiscal year, as officials rush to use expiring funds.

Automatic Cuts

Third-quarter defense spending rose 13 percent compared with the previous three months, an increase that may have been sharper than usual this year because government buyers sought to award as many contracts as possible before a year-end deadline for the automatic cuts, he said. In a last-minute deal between the White House and Congress, the reductions were delayed for two months.

“These numbers do on a monthly and quarterly basis move around,” Byron Callan, a defense industry analyst at Capital Alpha Partners LLC in Washington, said in a telephone interview. “It should be viewed more as an aberration as opposed to some new baseline or trend that people ought to think about in the balance of this year.”

Iraq War

A spokeswoman for the Defense Department said Pentagon officials don’t agree that the prospect of automatic cuts, known as sequestration, played a role in the lower defense spending.

“This is not our data and we cannot comment on the numbers, but the decline is likely a combination of reduced Defense spending to support the reduced activity in Iraq and Afghanistan and the limits in contractual activity engendered by the 6-month continuing resolution,” Pentagon spokeswoman Army Lieutenant Colonel Elizabeth Robbins said in an e-mailed statement.

The Obama administration’s top economist had a different view of the figures.

The 22 percent drop in defense outlays is probably due to “uncertainty concerning the automatic spending cuts,” Alan Krueger, chairman of the White House Council of Economic Advisers, wrote in a blog post yesterday after the Commerce Department released the figures.

Contracting Slowdown

The Commerce Department’s figures echoed a similar decline in the Pentagon’s announced contracts, which include only awards of $6.5 million or more.

Military awards dropped 18 percent to $94.8 billion in the quarter ended Dec. 31 from $115 billion in the previous quarter, according to data compiled by Bloomberg.

Spending on major Pentagon contracts weakened at the beginning of 2013. Awards slumped 23 percent to $10.1 billion in the first three weeks of January compared with $13.1 billion during the same period in 2012, according to the data.

“There’s a huge bottleneck where things have clearly slowed down,” said Stan Soloway, chief executive officer of the Professional Services Council, an Arlington, Virginia-based group that represents contractors such as SAIC Inc. and CACI International Inc.

Top defense contractors haven’t seen decreases in revenue in line with the Commerce Department’s figures, analyst Callan said.

‘Solid Plan’

Lockheed Martin Corp., based in Bethesda, Maryland, last week reported sales for the quarter of $12.1 billion, down less than 1 percent from the year-ago period.

“As we look at our go-forward plan for this year, we have a very strong portfolio and a solid plan in place,” Lockheed Chief Executive Officer Marillyn Hewson said during a conference call with reporters. “And even as we look at sequestration and potential budget reductions, we’re not looking at planned job reductions.”

Jennifer Allen, a Lockheed spokeswoman, said in an e-mail that until the full effects of sequestration are known, “there will be an overhang on our industry that stifles investment in plants, equipment, people, and future research and development essential to the future health of our industry.”

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