Transcription
Hello, I'm Jack Curran. I'm a senior analyst and team lead here at IVISWorld. Today, we're taking a look at the highlights of our most recent white paper, The Defense Dollar. I'm joined today by the author of that paper and one of our senior analysts, Evan JCowski. Evan, welcome.
>> Thanks. It's great to be here. Great to be talking about my work. Uh, really excited to get into this.
>> Yeah, I have to say I'm very excited to dive into this white paper with you. Um, defense spending, it really isn't something that I think the average person is thinking about all that often, but as you discussed in the white paper, defense is a major driver of the US economy.
>> We, we have quite an incredible amount of data on, on defense spending. A lot of it is kind of hidden behind these pretty, um, ownorous looking spreadsheets that, that the government posts every year. Um, from that, you know, you could see defense spending is 12.9% of our entire government budget and 47% of discretionary spending. The only things that account for more than that are, um, social security and basically general healthcare, and that includes Medicare, Medicaid, VA, and everything, you know, related to that. And when you think about that, how much money is going into actual defense spending, it, it's, um, quite daunting in a way.
>> Now, defense spending has been rising pretty consistently for the past few decades, but especially over the past five years. Up. What would you say is driving that growth?
>> Yeah, I, I, I think that you can highlight three main things. Um, that's rising tensions, changes to NATO spending benchmarks, and major advances in defense technology. Um, the first one's, you know, relatively straightforward. We're seeing really a renewed conflict in the Middle East, um, unprecedented conflict in Ukraine, just continued tensions in East Asia. You're looking at things related to the South China Sea, disputed borders that, these things haven't gone away. One of, one of the most interesting ones in my opinion is these changes to NATO spending benchmarks. Uh, traditionally this was a 2% mark, and that was specifically for defense capital, equipment, armed forces. So now what we're looking at is a 5% benchmark. 3.5% of that will be on that traditional defense capital that used to be 2%, and the other 1.5% is now explicitly for critical infrastructure, and that's, you know, along the lines of roads, bridges, waterways, cybersecurity, industrial investment. There are basically eight nations that are classified as some of the wealthier OECD nations, Canada, Italy, Spain, that have basically never come close to 2% spending margins. We're looking at what could be a really, um, unpredictable defense swing in the next couple years. And then really the last thing to get into is major advancements in defense technology. And we're seeing a lot of increases in unmanned warfare, drones, UAVs, um, that have played a major role. And it's shaping a lot of our military doctrine where we're focusing our spending. China just recently brought out their own fifth generation fighter. Russia's brought out theirs. We're competing pretty actively for, you know, advanced technology to maintain that superiority that, you know, it, it ties into the tech war that's been going on with semiconductors, resource conflicts with rare earth metals that, it, it really has its hands in every aspect of our economy, our industry.
>> So, what are some of the unique challenges facing the defense sector right now?
>> Three really key pain points, and that's consolidation, supply chain bottlenecks, and cost pressures. Um, we're, we're looking at a situation where in the 80s, 70s, there were 51 what the Department of Defense refers to as prime defense contractors, and they now list only five. We're seeing the situation where everything is so tightly packed that there's not really a lot of competition. Um, these companies don't really have an incentive to prioritize, um, these cost cuts that, you know, there, there's a certain level of government oversight that will force it, that will push, press the issue, but it, there, there's less of a competitive force compared to previous. And, you know, part of that is, is good because in a sense, we have such a technological barrier to entry in the first place that the, these kind of massive conglomerates are the only ones that really have the wherewithal to fully invest and push for these massive technological improvements. But you're also seeing a situation where no one else can even enter the market. Um, and on top of that, you have just some of these very prominent consolidation efforts. And you're looking at both vertical and horizontal integration, just making these incredibly complex supply chains. You have so many of these single sole suppliers that if something happens to them, the entire supply chain gets crippled. Again, you know, we, we've faced this really unprecedented period of supply chain disruptions during the pandemic. Um, and then further restructuring trade and shifting domestic regulations. Uh, the one that's most notable is, is the "Buy America" that we are now pushing that to 75% of content needs to be all American-made. So that's American steel, American electronics. Um, obviously, in, in many cases, the commercial industries will purchase from China, Vietnam, Eastern Europe, Mexico, whatever it might be. That's not an option for US producers. You're seeing things as simple as like screws and fasteners up 900% of what their normal cost would be.
>> That's because these contracts kind of are broadly split between fixed price and cost-plus contracts. You know, a majority of contracts fall under this fixed price designation. Um, and that's where contractors agree to deliver specific goods or services for predetermined fixed amounts. So they'll bid on a contract, and the government will say, "Okay, we'll want that contract for $300 million." And if that company goes over the, um, price that they bid, that they are responsible for any extra costs. And on the other side, there's these cost-reimbursement contracts where there's a few different styles, but one of the more common ones is a company will bid on a, um, determined margin. So the government will cover unexpected costs due to supply chain issues, labor disputes, whatever it might be. The government is, is kind of booked for those additional costs, and the company will be paid out a specific margin upon completion or upon certain benchmarks. Boeing last year in 2024, or two years ago at this point, um, logged more than $4.9 billion in losses across their defense contracts. That's like the T71 Red Hawk, um, a UAV contract. And this is just a consistent charge that these companies are facing that they're offsetting with their awardance of cost reimbursements, or, you know, smaller parts contracts that are easy to keep up their profitability.
>> Obviously, there is a lot that goes into defense spending. Um, you know, it's, it's so many different products and services involved here. Uh, but let's talk a little bit about where that spending has the most economic impact. How can defense industries impact job markets, uh, especially within local communities?
>> The Moon to Mars mission. Um, NASA releases these periodic reports, the last one in May 2022, um, stating that that program, um, directly contributed to more than 69,000 jobs, $14 billion economic impact, and $1.5 billion additional tax revenue. And obviously, th, this NASA's programs are largely concentrated in Florida, Alabama, Texas, that these are seeing a lion's share of, um, spending and economic development as a result. Um, the, there's, there's a follow-on report from October 2024 that suggests that the AY's total economic contribution actually reached $75.6 billion, and that they were contributing to 300,000 jobs. So now, as I mentioned, we get into some of these key local developments, um, that these defense contractors are so intrinsically tied to local and regional economies, and these perspective increases or decreases in defense spending are really driving economic development. Um, but we're looking at a situation where over-reliance can leave communities heavily overexposed to government shutdowns, program closures, reduced spending, consolidation. Um, suggesting that there, there needs to be an emphasis on, on manufacturing and potentially service diversification. You know, you, you're looking at a need that there maybe needs to be a little bit of, you know, funding for reskilling or upskilling to prevent the structural unemployment and these downturns that are very present. Long Island, where Grumman departed the region, uh, as part of its merger with Northrop. Direct employment was 25,000 at a peak, and now in 2013, there were only 850 administrative positions, which have all since been lost. Um, beyond this, almost all the subcontractors relocated, um, and service jobs completely replaced the region's manufacturing footprint. The Nassau County Commissioner of Commerce, um, say that tax revenues fell to a historic low in 1995, >> following the company's departure, and there was a significant, um, diaspora from many of these workers to St. Louis, New England, and other regions as they searched for the work that they were skilled at.
>> Tell us a little bit more about some of the complex dynamics that go into labor contracting for defense contractors.
>> Not only is it hard to find skilled workers, but you need to find workers that can receive the necessary, um, I guess, background checks to participate in classified programs. This is another significant labor barrier. Um, and we've also dealt with, they've dealt with a significant union presence and very recently unprecedented strikes and work stoppages. GE Aerospace very narrowly avoided a major strike, and they, they came to an agreement for, I believe, maybe a 35% wage increase. GE Aerospace holds a significant share of engine contracts as the sole supplier, along with a partnership with Safran for these engines. So them striking basically means that the rest of the supply chain can't do anything that, >> you see these lead times lengthen, maybe companies furlough workers, um, that it, again, highlights this intrinsic issue that exists in the supply chain. Pratt and Whitney recently settled a no-poach lawsuit. Um, that this basically suggested that the company, as well as many other parent subcontractors, had agreed to not go after each other's workers in order to artificially keep wage costs lower. We're likely to potentially see some significant wage increases over the next five, ten years as, you know, the, these workers start to jump ship, start to, you know, find better opportunities. Um, and that's just another cost pressure that we're looking for these defense contractors, but an opportunity for significant, potentially local economic development as well.
>> Let's talk about the export market. What are some of the factors at play with foreign military sales?
>> US is a dominant force in arms exports. That Stockholm Institute, uh, International Peace Research Institute estimates that the US accounted for 43% of global arms exports between 2020 and 2024. Um, no other nation accounted for more than 10% of arms exports, and only France, Russia, Germany, and China accounted for more than five. Um, the CRI also reports that US exports actually climbed 21% between 2019 and 2024. Uh, this has a large part to do with what's going on in Ukraine, as well as the Middle East. Uh, and just to kind of broadly understand where these exports are going, 35% end up in Europe, 33% in the Middle East, 28 in Asia and Oceania. Um, the US is also basically the only allied supplier of long-range strike weaponry, and that accounts for 45% of all exports. And keep in mind that this also accounts for countries that aren't aligned with the US. So, China and Russia also make up a large part of these exports. There's kind of two pathways for how the US transfers defense capital. Both are highly regulated, regulated, and require specific, um, authorization, rather being dual-use or military-specific under E and ITAR. Um, and these two are Foreign Military Sales and Direct Commercial Sales. Uh, Foreign Military Sales made up about 37% of total exports, with DCS making up the majority of the rest. Um, and there's some major Foreign Military Sales I think would be very interesting to highlight. Um, $825 million for delivered munitions to Ukraine, and further munitions guidance kits, $550 million, um, in munition support to Israel. And this really compensates a lot of that foreign aid that I mentioned. Um, the reason why Ukraine is one of the largest importers, $3.5 billion to Saudi Arabia for AAM missiles. A lot of these Gulf states have become some of the largest buyers for US munitions. Um, Saudi Arabia, Qatar, the United Arab Emirates are three to highlight. Um, there were a lot of major trade deals that had been, um, first implemented under the Biden administration, later upheld, advanced, um, by the Trump administration, currently. Um, the other one to really look at is the Direct Commercial Sales, which again make up the majority of exports, but the, these are largely a lot of high-volume dual-use sales. So you're looking at components, spare parts, customized systems, and these might require a little bit less direct government oversight, and they're more freely sold. Um, that being said, almost all Direct Commercial Sales from the US go to NATO plus 5 and Indo-Pacific allies. And this kind of highlights that this is just the continued policy prioritization, um, for the US and just industrial base alignment. And really a main reason why the US dominates these export markets is their extreme superiority in, in a lot of defense capital. Um, you could compare the Patriot missiles to the Iris LMS or Iris missiles that the, um, MBDA group is able to produce in Europe, that there, there's really not much comparison in both range, firepower, um, defense capabilities, as well as production timelines. And I think that that last one is honestly the most important of the three factors, that the US capacity completely outstrips what Europe is capable of doing, making Europe largely reliant on US product. And one thing to really highlight is the Ukrainian war has placed immense pressure on the NATO European supply of missiles, missile defense armaments, whatever else it might be. And most interestingly, NATO's, um, chief has specifically stated that they need five times as many air and missile defense systems to defend against a potential air invasion by Russia. And that really clearly outlines that there's major gaps in, um, Europe's stores of armored vehicles, tanks, artillery. Lockheed Martin specifically produces 600 Patriots, 1,400 GMLRs, 96 MRS, and 400, um, other like Predator missile systems, as well as almost 4,000 Javelin. You're looking at the German company Diehl, which is one of the major, major producers of the Iris TS SLM system, only produces about 400 a year. And that lead time is actually upwards of 18 months per missile system. So clearly that they, they lack the industrial base to take production where it needs to go. Poland and Romania have, for example, have taken investments from Raytheon and Lockheed to locally produce a lot of missiles. Um, and we're seeing all that money funneling back into the US economy at this point. Um, and in the short term, I think we're going to see a lot of these European buyers basically lean even more heavily into US production, both, you know, with these nearshore facilities, but primarily from major US facilities, and, and again, that's going to contribute heavily to our local economic development.
>> I think it's difficult to perfectly predict the future of defense. Uh, but given the current course, the current state of things, what would you say is on the horizon for the defense sector?
>> Just modernization efforts that, we're going to have major labor implications, major growth in these regional economies. That being said, we again run the risk of putting so much money into our defense spending that other parts of our, our economy, other parts of our government suffer. Um, this has been a question that has been on the minds of our congressional leaders for decades at this point. But at what point does defense spending become a zero-sum game where we're continuing to pile money into projects that may or may not succeed versus our healthcare, social security, veterans affairs, things of that nature that also require a significant amount of spending. And then on top of that, as I've mentioned, these cost pressures still exist. Um, we run into a system that is controlled by so few companies, and everything is so protected that we actually run a risk of falling behind technologically if we can't foster competition and foster innovation.
>> Well, Evan, congratulations on a fantastic white paper. I highly encourage anyone to give this paper a read. It has a lot of really great information and some really insightful analysis. Uh, a link to the white paper is available in the description of this video.