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Defense contractors fear fiscal cliff spending cuts will strike bone

8:03 AM, Dec 12, 2012   |    comments
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By G.W. Schulz

An estimated 1 in 4 jobs in San Diego County are tied to the military sector, and $32 billion in defense-related activities is linked to that area alone, more than the entire economic output of Panama.

So what happens if tens of billions of dollars in defense spending is suddenly yanked? Defense contractors and other employers are worrying aloud about the answer as Congress and President Barack Obama quarrel over tax increases and budget cuts and the country edges closer to the so-called fiscal cliff.

The bureaucratic term for this doomsday scenario is sequestration, and while many have expected a smaller military, more profound downsizing has a lot of people nervous in California and elsewhere.

"The damage is already starting to happen," said Chad Moutray, chief economist for the National Association of Manufacturers. "Many of our members are already seeing a slowdown in their sales, hiring and investment."

Deep spending reductions were proposed last year as a way to force lawmakers and the president to address the federal government's outsized budget deficit. If Congress and the White House take no action by Jan. 2, $500 billion in Defense Department cuts will automatically kick in over the next 10 years, with $55 billion of it expected in the first year.

The deadline that now looms has become part of a larger debate about defense spending. Obama already was eyeing $487 billion in cuts over the coming decade, and even some Republicans who have traditionally shielded the military's bloat now say the Pentagon is due for a diet.

How the economy will react isn't clear.

Marc King, president of Ceradyne Armor Systems Inc., based in Costa Mesa, Calif., said contractors are used to some amount of volatility in defense spending, and they prepare for it as much as possible even without the potential for sequestration. Recently acquired by 3M Co., Ceradyne employs 150 people in California to produce armor for vehicles, aircraft and combat troops.

Once Ceradyne adjusts its manufacturing process to support solar-panel production, windmills and oil-drilling parts, returning to meet sudden Defense Department demand for more armor is no easy task.

"It's a very long process, because right now there's a supply chain in place that supports all of this," King said. "Once you stop manufacturing, that supply chain eventually dries up. ... You just can't make chicken salad out of chicken feathers."

California is among states that could suffer most if sequestration cuts do kick in, Moutray said.

Today, tens of billions of dollars in contract transactions are signed each year by the Defense Department for work done in California. Although government contracting provides only a rough portrait, available public data show $40 billion in such transactions inked during the 2011 fiscal year.

Claude Chafin, a spokesman for the Republican majority of the House Armed Services Committee, said the consequences of cuts aren't just financial. Personnel is always a top expense, and if service members are shed in exchange for Pentagon savings, that could lead to a loss of institutional knowledge.

"There is a wealth of experience that we're going to need in the generation ahead that we run a very real risk of losing completely," Chafin said. "People who are the good captains and majors today, we need to be our future generals and admirals."

Longtime critics of federal largesse, on the other hand, have embraced the opportunity to condemn decades of hefty defense spending. Republican Sen. Tom Coburn of Oklahoma told reporters on Nov. 15 that his own party had a "blind eye" when it came to defense expenditures and was unwilling to include security spending in rhetoric about the need for smaller government.

Coburn's office released a report arguing a swollen Defense Department had taken on too many costs and initiatives that had nothing to do with national security.

"Our generals tell us the greater threat to our nation is not any foreign power. It's not the Middle East; it's not al-Qaida. It's our debt," he said. "So everything has to be on the table."

While the defense sector contends it's already being cut to the bone, the report points to more than 100 renewable energy initiatives launched by the Defense Department during 2010, more than any other federal agency, including the Environmental Protection Agency and the Department of Energy.

"This mission creep has essentially transformed the Department of Defense into the Department of Everything," the report derides.

Lynn Reaser, chief economist at Point Loma Nazarene University's Fermanian Business and Economic Institute in San Diego, acknowledges that there's no doubt the wars in Iraq and Afghanistan will wind down, so it follows that defense spending also will drop. But additional politically charged cuts occurring across the board are too haphazard of an approach for slimming down the Pentagon's waistline, she said.

A June report from the institute concluded that San Diego may fare better than other regions, partly due to the presence of special operations forces and new technologies like unmanned aircraft, plus a shift in the Navy's attention to the Asia Pacific. But defense programs, the report said, would still "face havoc" under sequestration.

"You cannot cut one ship by 10 percent, so you either forgo the total ship spending or you fund the ship and have to make major cuts in other areas," Reaser said. "The Budget Control Act was passed in 2011 with the consequences intended to be so severe and so unreasonable that they would never be allowed to happen. This was supposed to have been solved by the end of 2011."

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