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:: November 2016 Letter ::

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Dear Fellow Election Hangover Sufferers,

Defense programs and requirements are complicated. What capabilities and technologies do the nation’s armed forces need? What can the US afford? What metrics are best to assess program effectiveness, contractor performance, and economic viability? These questions need careful consideration: study groups, expert discussions, white papers, and oversight.

Or you can Tweet about them, in 140 characters or less. Our president elect seems to prefer this approach. The Presidential Aircraft Replacement program, the Air Force’s long-awaited acquisition of heavily modified Boeing 747-8s to serve as Air Force One planes, was the recent subject of a signature Donald Trump tweet. Linking to a tweet is silly, so I’ll just summarize Trump’s point in 43 characters: “Kill New Air Force One It Costs Too Much.”

I don’t tweet, but I do like economy of words. I’ll try to forecast the next four years for the defense industry in exactly the same number of characters: “Much Cash But Much Risk Of Pain And Shame” Okay, I left off the period at the end, but I got 43 characters. Here are more characters, and words: The Air Force One tweet reflects a fundamental contradiction in Trump’s objectives: he promises a big increase in spending (particularly defense spending), but he also promises reform and discipline. Those goals are tough to reconcile.

First, Trump’s vow to “rebuild” the military promises very good things for defense. Annual investment (procurement and research) accounts, now around $180 billion, are headed north of $200 billion. This will likely start with supplemental funding added next year to the FY 2017 budget, the final Obama request. Budget Control Act limits and Sequestration are now dead. Since Trump was elected, defense stocks are up by high single digit and even double digit percentages, nicely outperforming the broader market.

Meanwhile, Trump also wants a heavy infrastructure spending program, and enormous tax cuts. That’s deficit spending in hyperdrive. Is it sustainable? Is it good for the economy? I don’t know. But for the next few years (probably four) defense contractors will be awash in money.

But here’s the problem. As a populist, Trump promised “reform” and to “clean up that mess in Washington” and to “drain the swamp.” And of course, a “return to fiscal sanity.” None of this meshes with a huge defense budget increase, higher defense equity prices, and tax breaks for investors who benefit from those increases. As AEI’s Mackenzie Eaglen told the Washington Post, “the major defense contractors are part of the establishment he’s railing against.”

The way out of this conundrum is simple. Trump needs to occasionally make a public example of the companies who are benefiting from his plan. This explains Trump’s Air Force One drive-by shaming. Here are a few guidelines over how this process will play out:

Logic Doesn’t Matter. If a contractor is shamed, there may be little point in fighting back. Air Force One, for example, hasn’t seen any cost increases. The program is just starting. The budget, and cost figures, are set by Air Force requirements, not by corporate greed. Much of the budget isn’t going to Boeing. Assuming the project comes to $4 billion (the current budget plan is around $3 billion), just 20% of that will go to the 747-8 aircraft themselves. The rest will go to onboard anti-missile systems and electronic warfare systems, encrypted and secure communications, EMP hardening, etc. Many of these systems come from other contractors. They are also inherently quite expensive.

Transitioning from shaming to concrete action will be very hard. The day after his Tweet, Trump claimed he was merely starting a price negotiation. Exactly how does one re-negotiate capabilities here? “Do we really need the very best electronic countermeasures on the president’s plane? And how much electromagnetic pulse hardening do we REALLY need for the avionics?” Trump may find negotiating defenses contracts is harder than negotiating casino construction.

On to F-35. Or not. Going after a relatively marginal program that costs $3 billion over ten years is one thing; will Trump go after bigger targets? Consider the F-35, which Trump has previously criticized. As a $10+ billion per year program with a history of overruns and delays, it’s the most obvious target. On the other hand, for the Marines and Air Force, which Trump wants to “rebuild,” it’s the only game in town. Lockheed Martin and its partners may have a difficult four years ahead.

Will any of this work? And Will It Damage The Industry? Defense contractors know that resources are now plentiful, and again they hold the upper hand when they're (often) the only game in town (as with the F-35). This remains an industry with exceedingly high entry barriers, and Trump isn’t exactly likely to open borders for international competitors. On the other hand, defense is basically a monopsony. That makes the industry more vulnerable to rule by Twitter fiat than any other industry. Others can quietly open plants overseas and simply not invest more in the US until Trump leaves office. That Air Force One tweet had an immediate and direct effect on Boeing’s stock price; we may be in for some wild equities mood swings.

Is this part of a much broader emerging pattern of Big Government? Trump’s Air Force One tweet came right after some equally heavy-handed intervention in UTC/Carrier’s planned factory move to Mexico, and a loudly-proclaimed “success” in keeping a Ford plant in the US too. The tweet also may be retaliation for Boeing’s pro-free trade position, which is directly counter to Trump’s agenda. All of this speaks to a fondness for big government interference in private company decisions, and a shift away from market capitalism. Trump may be a Republican, but he may govern less like Ronald Reagan and more like Juan Perón.

So fasten your seat belts…it will be an interesting four years. And while we’re waiting for it to really start, November Aircraft Binder updates include the MRJ, Legacy/Phenom, T-50/KT-1, NH90, and King Air reports. Please note: we’re still running a bit late with these due to a new publication system; my apologies for that. And I hope you had a great month.

Yours, ‘Til Air Force One Gets A Secure And Encrypted Twitter Capability,
Richard Aboulafia
 

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