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Taiwan’s tallest building lit up with pro-Pelosi message.As military tensions flare between the U.S. and China over Taiwan, it’s easy to put all eyes on Nancy Pelosi and her visit to the island. Symbolism matters deeply in international relations, and this event is setting the direction for how Chinese and U.S. leaders will relate to one another. But six weeks ago, an obscure military bureaucrat named Cameron Holt offered another, equally important signal about this relationship. Holt is the head of acquisitions for the Air Force, which means he oversees the buying of everything from drones to nuclear missiles. And in a fascinating and spicy speech, he said that if the U.S. doesn’t get better at buying weapons, America will lose in a future conflict to China. “It’s simply math,” he argued.
The reason is that China is better at procurement. China is getting weapons “five to six times” more rapidly than the United States. “In purchasing power parity,” he said, “they spend about one dollar to our 20 dollars to get to the same capability.” This problem is directly related to market power in the U.S. Holt went over the business strategy of U.S. defense contractors, noting their goal is to lowball contracts but keep control of intellectual property. Then, he said, they create vendor lock-in, and raise prices later. In other words, they underprice upfront so they can eventually exploit pricing power over the Pentagon. Chinese acquisition strategies are more efficient and less brittle, which means over time their military will overtake ours.
Nothing Holt said is a surprise. Everyone knows how screwed up U.S. procurement is, the warnings come in almost daily. For instance, the U.S. can’t replace its stocks of Javelins and Stinger missiles sent to Ukraine, it’s going to take years to restart some of the assembly lines. Raytheon and Lockheed are having supply chain issues, and are unable to deliver weapons despite strong orders. We can’t even make the chips for weapons systems like the B-2 bomber, because semiconductor firms are shutting down the fabs that made the old parts. One could argue these are anomalies, unusual situations, but war is the ultimate moment of supply chain disruption, so that’s cold comfort.
To put the problem simply, we spend massively on weapons and get too little for it. Why? Just like health care or most other bloated sectors, it’s the prices, stupid. We consolidated economic power in the hands of a few dominant defense contractors and financiers, and they have become slothful and expensive. Fortunately, since it’s a problem caused by policy, it’s also a problem that can be solved by policy. And there are useful legislative attempts to do so.
Let’s start with how the U.S. organizes its defense thinking around procurement and economics. Traditional American strategy was laid out after the Revolutionary War, when U.S. policymakers recognized that to be an independent nation required domestic manufacturing and shipping capacity to reduce dependency on foreign actors, which through much of the 19th century was Great Britain. The idea we should be able to supply ourselves with industrial goods that could be repurposed for weaponry was key to every U.S. war, both then and since. For instance, in World War II, the U.S. became the ‘arsenal of democracy’ largely by transforming its peacetime industrial capacity to focus on industrial-scale warfare. Instead of cars, Ford factories churned out tanks and aircraft. Similarly, the Cold War aerospace industry in the form of Boeing and regulated airlines such as Pan Am served both civilian and military purposes.
Until the early 1990s, this basic strategy held; retain an industrial base for security purposes, so as to be able to produce lots of cheap interoperable machines and weapons if necessary. Public control over the defense part of this base occurred through competition; during World War II, there were more than a dozen prime contractors for every major weapons system. So if one entity screwed up or under-invested, military officers could procure elsewhere.
In the late 1980s and early 1990s, U.S. strategists changed this successful model of governance. The national security world and Wall Street, whose relationship had always been somewhat tense, became more aligned in their vision of how to project U.S. power. They coalesced around a dominant U.S. dollar, a strong financial system, high tech weaponry financed by large firms, and a globalized trading regime in which offshoring our manufacturing base helped create stronger relationships with foreign allies. Key to this strategy was fostering monopolization among weapons providers; from the end of the Cold War to the early 2000s, the number of prime contractors shrank from over 100 to 5, from a diverse set of actors to Boeing, Raytheon, Lockheed Martin, General Dynamics, and Northrop Grumman.
Policymakers in the Clinton administration also fostered contractor price gouging, especially on contracts where there was only one bidder, or ‘sole source’ contracts. A key way to do that was to eliminate contracting rules when buying things that were determined to be ‘commercial items.’ Originally meaning that contracting rules didn’t apply to things like pencils or off-the-shelf computers that are regularly sold to private citizens, Congress changed the meaning of ‘commercial items’ in the mid-1990s to mean anything, like military transports or sophisticated weapons system that are anything but commercial. Since the Pentagon is the biggest buyer in the world, this change had significant impacts on market structures across the board.
For example, the C-130 transport - which has never been sold to a private commercial party - is considered a ‘commercial item.’ And its price, which should come down as technology and manufacturing know-how improves, has skyrocketed, from one model selling at $37.5 million in 1994 to a slightly bigger version going for $200 million apiece today. Why is the price so much higher? Well, procurement officers can’t get cost data, because it’s a ‘commercial item.’ And so they lack bargaining leverage.
TransDigm is a more blatant example. Transdigm is a company that bought up sole source providers of spare parts and raised prices; in one case they overcharged DoD as much as 4,451% on certain items. Indeed, according to the Pentagon’s inspector general, current regulations “enable sole-source providers and manufacturers of spare parts to avoid providing uncertified cost data, (which, if you want to get technical, is a much weaker and less reliable version of the certified cost data that contractors were routinely required to submit prior to the Clinton Administration’s embrace of defense contractors). Numerous government reports have repeatedly shown that the Pentagon pays too much for spare parts. For example, IGs found that companies charged DoD $71 for a pin that should have cost less than a nickel and $80 for a drainpipe segment that should have cost $1.41.
The notion of a commercial item has gotten ridiculous. Here, for instance, is Raytheon trying to pretend that its military drones are somehow sold in the commercial marketplace.
Giant contractors aren’t just trying to sneak in policy loopholes, they are advertising them.
The post-Cold war Wall Street-national security strategy has eroded U.S. ability to actually produce the things we need - which includes weaponry. And while not being able to build lots of functional weapons didn’t matter when opponents were simply bands of low tech terrorists, nation states like Russia and China present an actual need for industrial capacity to make weapons. As former Marine and Congressman Paul Cook put it a few years ago, “the system we have right now, I swear to God, we would have lost World War II.”
Over the last few years, because of Wall Street’s dovish posture to China, the Wall Street-national security alliance has been breaking down. In 2021, the Pentagon sent Congress a groundbreaking report on how Wall Street is destroying the defense base. “A U.S. business climate,” it read, “that has favored short-term shareholder earnings, deindustrialization, and an abstract, radical vision of ‘free trade,’ without fair trade enforcement, have severely damaged America’s ability to arm itself today and in the future.” The report asserted that “The number of cases where there is just one – often fragile – supplier is staggering. This is a deterioration from a decade ago when 3 to 5 suppliers existed for each component, let alone several decades ago when the military generally enjoyed dozens of suppliers for each item.”
These warnings are translating into policy changes. Earlier this year, the Federal Trade Commission and the Pentagon blocked the merger of Lockheed Martin and rocket engine producer Aerojet. That same team - Lina Khan at the FTC and Kathleen Hicks at DOD - are considering breaking up Northrop Grumman by reversing its 2019 merger with Orbital-ATK. These are shocking moves to address contractor consolidation. But there’s also movement to address contracting rules themselves.
In different versions of this year’s National Defense Authorization Act, there are two proposed changes to the immensely complex contracting rules the Pentagon uses to source goods and services. The first - Section 822 - is to mandate firms that sell commercial items to the Pentagon to actually show that these items are sold in the commercial marketplace. It’s not as strong as it could be, and only applies to items going forward and not to things like the C-130 that have already been designated commercial. It’s also hard for the procurement officer to take advantage of the law, they must get permission from their superior to demand cost information. But it’s a useful step.
And the second is to address the problem of what are called ‘progress payments,’ and change the way the DOD sends out money so that it only pays big contractors cash when they actually complete their work. When you contract with a firm to build a weapons system, they seek cash as they get going and proceed with work. But at the same time, you don’t want to give them the entire amount, because they then have no incentive to finish the project and the government doesn’t yet have the weapons in hand. During COVID, the Pentagon accelerated the payment of cash to defense contractors in response to what these firms said was an emergency, which meant that these firms could get up to 90% of their incurred costs in cash even before they ever delivered a finished product. They ostensibly needed more money upfront to address supply chain problems and help subcontractors. (Of course, what a lot of them really did was buy back stock.)
This provision creates a mechanism for the Pentagon to roll that progress payment amount back to 50%, and reward contractors with higher amounts if they are more reliable, do higher quality work, and so forth. It’s a pilot program and sunsets, but it would enable more power for procurement officers.
Both of these changes seem pretty simple and are similar to the Stop Price Gouging the Military Act, which is proposed legislation by Rep. John Garamendi and Senator Elizabeth Warren. If firms want to sell to the Pentagon and avoid the rules because it is a commercial item, they should have to show that what they are selling is available and actually sold in substantial quantities in the commercial marketplace. And if a firm wants more cash as it incurs costs prior to delivery of the final product, it should have a good track record.
The Pentagon should operate with the leverage of power buyers such as Walmart or Amazon, which can structure markets because of the volume of stuff that they buy. Even though the Pentagon is much bigger, the DOD culture is largely one in which leaders and procurement officers think that they are lucky if contractors deign to do business with them. That’s a crazy way of thinking. Our military has never been so supine in front of big business and Wall Street as they are now. It is a dangerous and costly way of operating. I hope we can turn that around. If we don’t, then the consequence will be losing a major war with a nation who spends a lot less on their military but gets a lot more bang for their buck.