Defense trade currents

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The legacy of the draconian cuts in military force levels and procurement during the 1990s continues to cast a pall over U.S. national security planning. That American soldiers and Marines have been overstretched by repeated deployments in Iraq and Afghanistan is well-known, and steps are being taken to expand their strength. It is not just the combat forces, however, but the defense industry upon which they depend for arms and equipment, that also needs to be reconstituted.

The "procurement holiday" of the Clinton administration cost the defense industrial base a million jobs. The Pentagon promoted a consolidation of firms and elimination of "excess" capacity. This reform was supposed to improve efficiency but it also reduced domestic competition. Now, to stimulate competition, or even just access sufficient capacity, foreign firms are invited to supply U.S. forces with hardware. The most recent example is the awarding of a $35 billion U.S. Air Force contract for 179 new KC-45A aerial refueling tankers based on the Airbus A330 airliner built by European Aeronautic Defense and Space Company (EADS). Boeing has built every previous USAF tanker and has won contracts for its KC-767 tankers from Japan and Italy. But it lost the military competition at home to the foreign firm that is also its main global rival in the commercial airliner sector.

The USAF contract comes at a critical time for EADS. Its A380 "superjumbo" airline project is well behind schedule, and there have been problems in the Airbus A350 midsized airliner project (crucial to its future battles with Boeing), and in its A400M military airlifter. EADS is Europe's largest defense contractor yet is much smaller than Boeing because Europe went on an even deeper disarmament slide after the Cold War and has done little to reverse course.

The once-mighty NATO armies deployed to stop a Soviet blitzkrieg across Germany have melted away to where they can hardly maintain a few brigades in Afghanistan to fight lightly armed insurgents. European firms are desperate for American taxpayers to bail them out with military contracts. The question is: Can the United States depend on a steady supply of production, including decades of space parts and upgrades, from foreign industries in decline — and where military investment and research are funded at only a fraction of what America devotes to defense?

Faced with adversity, how defense contracts affect the larger economy is given great attention in Europe. When an American firm sells military equipment in Europe, it must provide "offsets" against the cost of the contract. Such offsets include mandatory co-production, licensed production, subcontractor production, technology transfer, counter trade, and foreign investment.

The object is for the buyer to recoup as much as possible from the seller. According to a December report by the Commerce Department's Bureau of Industry and Security, "During 1993-2006, U.S. companies reported entering into 582 offset agreements with 42 countries related to export sales totaling $84.3 billion. These offset agreements were valued at $60 billion and equaled 71.2 percent of the export contract value." For European countries, the offsets equaled 97.7 percent of contract value.

At an offsets conference I attended in London last year, a Turkish official recounted how, in order to fulfill an offset, Sikorsky set up a joint venture with local partners that became its sole-source supplier of tail rotor assemblies — including for helicopters sold to the U.S. military. Thus, an entire piece of the American defense industrial base was moved overseas.

The Airbus A330 has components built in Britain, Germany, France and Spain, the result of "work sharing" negotiations between the governments. This is not very efficient, but Airbus has received heavy government subsidizes to be more competitive in world markets. The United States is still pursuing action at the World Trade Organization against EADS, alleging illegal export subsidies for its commercial aircraft programs. Yet, the case did not disqualify EADS from the USAF contract.

Boeing will protest the contract award on procedural grounds, but the debate should become broader to include an assessment of how such projects affect the nation's ability to meet military needs securely and reliably.

At a Senate Armed Services Committee hearing March 12, Air Force Secretary Michael Wynne conceded that industrial issues had not been taken into account when awarding the bid. "The way our industrial base is shrinking is something the Congress should take a look at," Mr. Wynne said.

There are "Buy America" provisions that apply to this project from which the country benefits. At least 50 percent of the value of the contract must be done in the United States, and EADS had to take an American partner to have any chance of winning the bid. As a result, the KC-45A's European-made airframe will be assembled in Alabama by Northrop-Grumman, its General Electric jet engines will be built in Ohio, and its refueling system in West Virginia.

Domestic content rules are vital to sustaining production capacity and should be expanded. The United States needs to use the leverage of its large market to promote "in-sourcing" by foreign firms to bring capital and technology into the American economy.

William Hawkins is senior fellow for national security studies at the U.S. Business and Industry Council.