Costello’s Action Plan

Sept. 1, 1988

Washington, D. C.—The Pentagon, after struggling with the problem of the de­fense industrial base for more than a year, presented its report in July. Dr. Robert B. Costello, Under Secretary of Defense for Acquisition, called the study an ‘action plan to bolster de­fense industrial competitiveness.” The action it prescribes for the near future, though, is mostly organiza­tional and preparatory. It would create various new offices and task forces in the bureaucracy to wrestle with the problem and to gather more data.

The industrial base issue is hot in Washington power circles. Many in Congress want to move faster than Dr. Costello’s plan proposes. On Capitol Hill and elsewhere, the prevailing opinion is that the Defense Depart­ment has handled the problem poorly up to now. Indeed, the report ac­knowledges that the Pentagon’s in­dustrial base strategy has led to “insufficient resource allocations, confusion, and lack of effectiveness.”

The situation, as confirmed by the report, is serious. The United States is rapidly losing jobs, business, and high-technology leadership to for­eign nations. We have become depen­dent on those nations for critical weapon system components. The US defense industry is undercapitalized, and its physical plants are outdated. The industry is falling behind in both quality and productivity. Frequently, government policies have unforeseen side effects and often make bad cir­cumstances worse. Our schools and colleges are not meeting the require­ment for technically prepared man­power.

Dr. Costello’s plan does not address an older aspect of the industrial base problem that has worried defense professionals for many years: that US industry has no real capacity for war­time mobilization or surge produc­tion.

Additions to the bureaucracy have begun, however. A Defense Manufac­turing Board—modeled on the highly regarded Defense Science Board—has been established. It will work with a Defense Manufacturing Strategy Committee that the National Acade­my of Sciences has agreed to set up. A “production advocate”—a Deputy Under Secretary of Defense for the Production Base and International Technology—will be appointed. Re­porting to this new official will be a Strategic Planning Task Force.

One of the assignments given to the study team was to identify “defense-critical” companies. It found that there are 215 of them and that they account for about ninety-five percent of defense purchases from the man­ufacturing sector. Between 1980 and 1985, these firms were below the US average in productivity growth, cap­ital investment, and additions to their productive capacity. The report says that the 215 companies achieved aver­age or above-average profits during that period.

The defense procurement process focuses on prime contractors, al­though materials and components from subcontractors amount to fifty to eighty-five percent of the total cost of purchases. The report admits frankly that “the Department of De­fense does not know the extent to which foreign-sourced parts and components are incorporated in the systems it acquires” and that there is “no reliable system even to identify such dependencies, not to mention systems to minimize them.”

To improve the storehouse of infor­mation on the state of the industrial base, Dr. Costello wants to merge and adapt two programs now in their for­mative stages, the Defense Industrial Network and a Defense Intelligence Agency project named SOCRATES.

The plan calls for an integrated re­view of tax, trade, and domestic poli­cies with a view to making them co­herent. It observes, for example, that present tax policy provides no incen­tive to industry to invest in plant and equipment improvements or upgrade training for its work force. It also says that “the policies of other govern­ments to subsidize and protect their industries are not matched by the United States government,” whose “policies and actions to level the play­ing field in international trade have been inadequate.”

It further says that “United States tax laws should differentiate between wealth-producing activities and wealth-redistributing activities in treating amortization and deprecia­tion. Productive investment could re­ceive more favorable tax treatment than such activities as stock-market speculation. Rare instances of United States government efforts to foster domestic manufacturing are best characterized as efforts to correct the results of prior neglect and usually focus on lagging rather than leading industries.”

Commentary in the report about practices of the Defense Department and the services should be read with special interest. Dr. Costello has not yet consolidated his power as the “acquisition czar” that Congress wants him to be, but the clout of his office is significant, and the philoso­phy expressed in the plan may be as important as some of the specific ac­tions.

“The separation in the industrial base between defense and commer­cial production is nearly absolute,” the report says. “There are few exam­ples of firms that produce both mili­tary and commercial products in the same plants. There are firms that serve both markets, but they invari­ably maintain rigid separation be­tween the two lines of business.

“These firms, however, do have a more informed view of the difficulties involved in attempting to integrate production of military and commer­cial products. Their perceptions are that barriers to integration range from immense burdens imposed on de­fense contractors by government rules and regulations (including, for example, cost-accounting standards that require defense contractors to keep two sets of books) to the unique requirements of thousands of de­tailed process and product specifica­tions (which frequently are obsolete by the time they are promulgated). In many product and process technolo­gies, commercial practice has sur­passed defense practice, with the re­sult that the Department of Defense often pays more for less advanced products.”

The relationship of defense and commercial markets is central to the industrial base problem, especially in electronics. The armed forces, once the primary customers of the semi­conductor industry, now buy only three percent of the total quantity pro­duced. The market is driven by com­mercial demand, not by military con­siderations. (See also the article “Our Endangered Industrial Base,” October ’87 issue.)

Dr. Costello and his staff contend that “the deeply ingrained adversarial relationships between government and industry and between manage­ment and labor are major causes of declining American industrial com­petitiveness.” In a personal post­script, Dr. Costello writes that “one key recommendation in this report, perhaps the highest priority, is di­rected to forging better relations with industry.”

The report is anything but a love note to industry, declaring that “the findings of this study are, collectively, an indictment of management in American firms.” It contends that many top managers “continue to view the nature of markets as national, not international, and the nature of prod­uct requirements as good enough, not world class.”

In his postscript, DoD’s acquisition chief says that “proper cooperation between industry and government is essential for creating a win-win situation for both parties and ensur­ing the existence of a healthy and vital industrial base from which the De­partment can draw its mission effec­tiveness.”

Few would argue that this is essen­tial. But there is considerable doubt about whether this plan is adequate to make it happen.

The Volunteer Cost

Selective Service sent out its last draft call in December 1972. The last conscript entered the US Army on June 30, 1973. Fifteen years later, though, the All-Volunteer Force is still controversial. Two recent assess­ments reach radically different con­clusions about the relative cost of vol­unteer forces and conscript forces.

One evaluation appears in “Citi­zenship and National Service,” pub­lished by the Democratic Leadership Council, whose chairman is Sen. Sam Nunn (D-Ga.). It proposes a “Citizens Corps” in which young Americans would perform one or two years of civilian or military service at subsis­tence wages. In return, they would earn vouchers that could be used to pay for college expenses, vocational training, or down payments on homes. Polls say that Americans, young people especially, like the idea.

The Citizens Corps envisions a two-tiered military. Those joining under the new concept would be assigned to labor-intensive specialties in com­bat units. They would get no bonuses and would be required to live in dor­mitory housing. They would serve for two years and be paid at half the reg­ular rate. After active duty, they would remain in the reserves for two years.

To support its proposal, the Council quotes sociologist Charles Moskos, who says that manpower costs in the all-volunteer era are sixty-six percent higher (inflation factored Out) than they were during the draft. It also cites research by Martin Binkin of the Brookings Institution. Since the number of eighteen-year-old males in the United States is declining, Mr. Binkin says, the Army in 1991 will have to recruit fifty-five percent of all young men eligible to serve in order to hold its strength at present levels.

An altogether different picture on cost emerges from a new study done for the Department of Defense by Syl­logistics, Inc. It says that a conscript force with the same mix and effective­ness as the volunteer force of 1985 would have been about $1.1 billion more expensive. Even a less-experi­enced force mix, approximating the one of 1965 in the draft era, would have cost $500,000 more than the 1985 volunteer force did. Syllogistics says that favorable cost comparisons for conscript forces are usually achieved by substituting, on a one­-for-one basis, draftees with less than two years of service for volunteers with four years of experience.

In reality, an appreciably greater number of draftees would be required to achieve comparable results. Train­ing wave after wave of conscripts is costly, and it also diverts experienced people from operational units to training functions. Under a draft, it is cheaper to acquire people initially, but more costly to build a force mix with the proper levels of experience and effectiveness.

“Most or all of the savings that are expected to result from implementing conscription are actually the result of reducing effectiveness by decreasing the size of the career force,” Syl­logistics reports.

In testimony to the Senate earlier this year, Grant S. Green, Jr., Assistant Secretary of Defense for Force Man­agement, attacked the “mistaken be­lief” that “the declining youth popula­tion will make it impossible to attract enough qualified recruits. . . . When the youth population peaked in 1979, none of the services achieved their recruiting objectives. When the youth population bottoms out [in the 1990s], we will need a smaller propor­tion of the youth population than was required in 1974—a very good recruit­ing year.”

Gorbachev’s Industrial Base

If the US industrial base is a prob­lem, its counterpart in the Soviet Union qualifies as a nightmare. Half­way through the Twelfth Five-Year Plan (1986-90), worker productivity is still low, the quality of industrial ma­chinery is still poor, and things are not improving very rapidly.

The Central Intelligence Agency and the Defense Intelligence Agency, in their annual report to Congress on the Soviet economy, said that Soviet GNP grew by less than one percent last year, the lowest rate since the 1970s. Industrial production was up by only 1.5 percent, about on a par with the poor rates achieved in 1981-85.

The machine-building industry—centerpiece of General Secretary Mikhail Gorbachev’s modernization plans—actually struggled to keep production levels from falling. The machine builders, according to the report, are “being forced to do every­thing at once: retool, increase quality, conserve resources, change the product mix, and accelerate produc­tion.” As with other sectors of Soviet industry, they are finding the new quality-control program (gospriyem­ka) disruptive and overwhelming. One Soviet economist blames gos­priyemka for thirty-five percent of the failures to achieve machine output goals. At one point, inspectors were rejecting twenty percent—and some­times far more—of the products they checked.

There is pressure, some of it from Mr. Gorbachev himself, to reallocate resources from defense to other sec­tors of the economy, such as food pro­cessing. Defense procurement ap­pears to have grown by about three percent last year, though, and major programs continued on track.

The CIA-DIA report says that “defense industrial participation in the civil modernization program is unlikely to affect weapons production capabilities greatly, at least for the next few years. As a result of the large-scale modernization in the defense industries in the 1970s, the sector has in place most of the equipment it needs to produce weapon systems scheduled for deployment through the early 1990s. Therefore, any invest­ment forgone in weapons plants to supply tooling for civilian production could only delay the introduction of future weapon programs, but would not be likely to slow current output.

“Nonetheless, Soviet defense in­dustry is not without its own pressing needs. In the near future, if not this year, it must begin serious commit­ments to support the next generation of Soviet weapons. Any move to re­allocate resources from defense in­dustry, however—even if it affects only future weapons production—would be controversial and could spark opposition from more conser­vative elements in the leadership.”

Packard on Pentagate

David Packard—whose Blue-Rib­bon Commission wrote the book on defense procurement reform—gave the Senate Armed Services Commit­tee a blistering perspective on the so-called “Pentagate” allegations of bribery and fraud in defense contract­ing.

“In my opinion, the [Defense] De­partment, the Administration, and Congress together have created an environment in which honest and effi­cient military acquisition is impossi­ble to implement,” Mr. Packard said during his testimony.

He told the Senators that “many of the things that have come to light are not the problems but rather are symp­toms of the problems” and that the underlying cause is that “defense procurement has been microman­aged to death.” He expressed his agreement with Secretary of Defense Frank C. Carlucci that the process in­vites abuse and improper attempts to influence contract awards.

In a July 9 speech, Secretary Car­lucci said that “the procurement pro­cess has become exceedingly cum­bersome and complex—charac­terized by multiple decision points, each of which provides opportunities for congressional micromanagement and influence by special advocates.

As a result, the process creates incen­tives that reward precisely what we want to avoid. The traditional risk-re­ward ratios used by business have driven contractors to maximize short-term profits and seek advantage in the political arena,” and ‘the best way for contractors to do that in our cur­rent system is to invest in ‘market in­telligence,’ a euphemism for hiring consultants and lobbyists to inter­vene in the process in the executive branch and on Capitol Hill.”

Mr. Packard said that he was all for audits and investigations to ferret out criminals and bring them to justice, but added that “this country has long-established procedures to deal with crime. They should not be preempted in the name of military reform.”

The government has gone over­board in emphasizing competition among contractors, Mr. Packard said. He charged that on most big pro­grams, the competition has been chiefly in “tons of paperwork describ­ing how the bidder would meet a bunch of Mickey Mouse requirements that have absolutely nothing to do with doing the job right.”

Congress has been reluctant to im­plement two-year budgets and multi­year funding of major programs, fea­tures that the Packard Commission said were essential to procurement reform. Mr. Packard charged that “the real reason Congress will not approve multiyear funding, in my opinion, is that to do so would severely limit their pork-barrel opportunities.”

He also denounced “the dis­graceful congressional practice of funding programs for equipment that is not really needed by our military forces” and asked, “How can Con­gress expect ethical behavior from the DoD and the defense industry when it sets such a bad example of ethical behavior at the top?”

Mr. Packard called for an end to the source-selection dickering that culminates in a call for each compet­ing contractor to make its “Best and Final Offer.” “That practice should be stopped,” he said. “It is operating mil­itary acquisition like an Iranian ba­zaar.” Others have noted that it is when the government begins this round of last-minute bid revisions that the competition frenzy peaks and in­sider information becomes most valu­able. At a July 25 press conference, Secretary Carlucci said the Pentagon is “attempting to restrict our con­tractors to one best and final offer.”

The best thing Congress could do to improve military acquisition would be to add “a large measure of common sense to the process,” Mr. Pack­ard said.

“The breakdown of the procure­ment system is caused by two things: the attempt by Congress to impose competition in a situation in which real competition in the conventional context is virtually impossible to achieve and [the attempt] to try to im­pose competition by a myriad of unre­alistic rules and regulations enforced by what I consider to be identical to police-state tactics.”

Mr. Packard chastised the services for failure to streamline the procure­ment bureaucracy. The Commission intended to give a message to the armed forces that there should be only one chain of command in system acquisition, he said. But “so far,” he charged, “they have flunked out on this issue.

“It may be that the only way to deal with this issue is for Congress to man­date a reduction on the order of twen­ty percent in the number of people in the DoD and in the services who are involved in acquisition. I am abso­lutely sure a better job would be done with twenty percent fewer people. I would not recommend such a reduc­tion unless a corresponding reduc­tion were made in the number of peo­ple on congressional staffs.”