Bloomberg News

Defense Spending Slides in Biggest Drop Since Vietnam

January 31, 2013

(Corrects Hewson comment and reference to conference call in last paragraph of story published Jan. 30.)

Defense spending plummeted in the last three months of the year, which may foreshadow the dangers to the economy of across-the-board budget reductions set to kick in March 1.

The 22 percent drop in Pentagon expenditures is probably due to “uncertainty concerning the automatic spending cuts,” Alan Krueger, chairman of the White House Council of Economic Advisers, wrote today in a blog post after the Commerce Department released the figures.

The decline in defense purchases in the fourth quarter was the biggest since 1972, when military spending slumped in the closing years of the Vietnam War. The reductions may reflect the winding down of two wars and $487 billion in cuts already planned over a decade. The automatic defense cuts would total $45 billion this fiscal year, according to the Pentagon.

“This reflects anxiety over the cuts but also a general downturn in defense that’s been expected,” said Kevin Brancato, an analyst at Bloomberg Government in Washington.

The fourth-quarter outlays don’t reflect a sharp contraction in annual defense spending. While defense outlays plunged 22 percent from the previous quarter on an annualized basis, spending for the year fell just 3.1 percent from 2011, according to Benjamin Mandel, an economist at the Commerce Department’s Bureau of Economic Analysis.

Defense expenditures totaled $677.2 billion in inflation- adjusted dollars in 2012, compared with $699.1 billion in 2011, according to bureau figures.

Delayed Cuts

The fourth-quarter decline partly reflects a spike in defense spending during the prior quarter, Brancato said. The Pentagon traditionally spends the most in the third quarter, which marks the end of the government’s fiscal year, as officials rush to use expiring funds.

Third-quarter defense spending rose 13 percent compared with the previous three months, an increase that may have been sharper than usual this year because government buyers sought to award as many contracts as possible before a year-end deadline for the automatic cuts, he said. In a last-minute deal between the White House and Congress, the reductions were delayed for two months.

“These numbers do on a monthly and quarterly basis move around,” Byron Callan, a defense industry analyst at Capital Alpha Partners LLC in Washington, said in a telephone interview. “It should be viewed more as an aberration as opposed to some new baseline or trend that people ought to think about in the balance of this year.”

No Budget

The automatics cuts will take place unless the Obama administration and Congress work to stop them. It’s “more likely than unlikely” that the reductions will take effect, Deputy Defense Secretary Ashton Carter said yesterday.

A spokeswoman for the Defense Department said Pentagon officials don’t agree that the prospect of automatic cuts, known as sequestration, played a role in the lower defense spending.

“This is not our data and we cannot comment on the numbers, but the decline is likely a combination of reduced Defense spending to support the reduced activity in Iraq and Afghanistan and the limits in contractual activity engendered by the 6-month continuing resolution,” Pentagon spokeswoman Army Lieutenant Colonel Elizabeth Robbins said in an e-mailed statement.

Contracting Slowdown

A stopgap measure in place that allows government agencies to continue programs at the previous year’s funding levels expires March 27.

If Congress allows the stopgap to continue, it will affect “every one of our sectors,” Wes Bush, chief executive officer of Northrop Grumman Corp. (NOC:US), told analysts on a conference call today.

“We see this environment with those types of restrictions touching all types of business” within Northrop, Bush said.

The Commerce Department’s figures echoed a similar decline in the Pentagon’s announced contracts, which include only awards of $6.5 million or more.

Military awards dropped 18 percent to $94.8 billion in the quarter ended Dec. 31 from $115 billion in the previous quarter, according to data compiled by Bloomberg.

‘Huge Bottleneck’

Spending on major Pentagon contracts weakened at the beginning of 2013. Awards slumped 23 percent to $10.1 billion in the first three weeks of January compared with $13.1 billion during the same period in 2012, according to the data.

“There’s a huge bottleneck where things have clearly slowed down,” said Stan Soloway, chief executive officer of the Professional Services Council, an Arlington, Virginia-based group that represents contractors such as SAIC Inc. (SAI:US) and CACI International Inc. (CACI:US)

Top defense contractors haven’t seen decreases in revenue in line with the Commerce Department’s figures, analyst Callan said.

Lockheed Martin Corp. (LMT:US), based in Bethesda, Maryland, last week reported sales for the quarter of $12.1 billion, down less than 1 percent from the year-ago period.

“As we look at our go-forward plan for this year, we have a very strong portfolio and a solid plan in place,” Lockheed Chief Executive Officer Marillyn Hewson said during a conference call with reporters. “And even as we look at sequestration and potential budget reductions, we’re not looking at planned job reductions.”

To contact the reporters on this story: Nick Taborek in Washington at ntaborek@bloomberg.net; Brendan McGarry in Washington at bmcgarry2@bloomberg.net

To contact the editor responsible for this story: Stephanie Stoughton at sstoughton@bloomberg.net


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