 So good afternoon to everyone on behalf of the Center for Strategic and International Studies. I want to welcome you to our afternoon panel You are welcome to balance eating and listening. It's a combination of skills of which I think your mother would approve The We're going to try our best not to give you indigestion Even though the topic that we're undertaking is certainly one that has the potential in that regard If you turned on your cell phones when you went out to get your food Would you please silence them now and and welcome also to our audience on the web and for those who are watching this Postmortem if you will Defense spending has always run in cycles and nearly everyone agrees We're at the beginning of the next decline in defense spending. We call it a budget drawdown We do this in America after every war we did after World War two we did after Korea Did it after Vietnam did it after the Cold War? The Defense Department of course in addition to drawing down budgets after wars is also very good at collecting lessons learned They're not quite as good at actually learning and applying those lessons and to help them We've assembled the panel today of People who actually made a number of the key decisions at various stages in the last budget drawdown I will introduce them at the end when they come up on the stage here first though I want to run you through a series very quickly of facts and figures where we stood in 1988 which was at the end of the Carter Reagan build-up and Where we stood in 2008 which was the peak of the post 2001 build-up It's the 2000s we call it the aughts for purposes of this briefing Here the blue bars are the budget authority for each fiscal year left-hand side starting in 1988 going down through the 1990s back up in the aughts and ending at 2008 with supplemental appropriations after 2001 shown in red All of these are in constant 2012 dollars, so it's comparable over time. That's why it's 500 billion into in 1988 you can see the drawdown It's 28% between the peak in 88 and the bottom in 98 and you can see the build-up from the aughts You can also see that a lot of the build-up was spent on War-related costs much of which is included in the red part of each bar now Let's compare 1988 and 2008 for a few selected defense statistics First personnel top is a comparison of dods personnel the civilians are red the active military in blue 1988 on the top 2008 as the next line down the ratio of civilians and military remain Roughly constant at two to one, but overall dod personnel dropped 34 percent from 1988 It's worth noting in real-dollar terms This one-third fewer people cost the same in 2008 as more people did in 1988 We've cut people but the dollars are essentially the same The bottom is a comparison between the number of us major bases in 1988 and in 2008 We have around five rounds of base closures. We call them BRAC between 1988 and 2008 And they reduced dods major bases by 24 percent now overseas bases came down by a much larger percentage But as you can see dods saw steeper reductions in personnel than in major bases during this 20-year period Now let's look at equipment the build-up of the 1980s actually expanded the inventory of major platforms Spending increases in the aughts have not produced similar inventory levels So this slide compares the inventory levels of major platforms between 1988 and 2008 down the left You can barely read them, but that it actually gives you the major platform categories bombers tanks warships submarines helicopters fighter aircraft aircraft carriers and airlift The full-scale which is a red and blue combined Essentially captures the 1988 inventory levels the red portion on the left shows those platforms inventory levels in 2008 and on the right-hand side are the percentage changes in the inventory between 1988 and 2008 so all the major platforms are below the 1988 levels Strategic bombers at the top 57% decline Airlift at the bottom with only a 13% decline in numbers So these platforms of course are still very important parts of our defense structure and our combat capability It's probably worth noting though this chart doesn't capture some of the new Elements of the force today. It doesn't have unmanned. It doesn't have cyber. It doesn't have missile defense doesn't capture electronic warfare If you had those kinds of things some of which are not really platforms if you will it would show a somewhat different picture But overall I think the point is clear our inventories for the most part are far below 1988 levels and most of them have fallen at a higher level than the 34% reduction in personnel We not only have fewer platforms in the inventory the ones we do have are a lot older This chart shows the average age of inventory of major platforms listed across the bottom the blue bars are the average age of the platforms in 1988 the red bars are the average age in 2008 So the average age of all the platforms except for navy Battle force ships, which is the third set of columns there are higher today than they were in 1988 These dotted black lines show a conservative estimate of the average half-life of those systems The lines are based on a report from the congressional budget office And while there's no precise figure that represents too old in the sense of a platform Clearly our platforms are older on average today than they were at the start of the last drawdown And in many cases that age exceeds the benchmarks This raises the question of today's purchasing power And whether or not do d can replace this inventory as needed as it ages further So let's look at the purchasing power All right, this chart shows the investment accounts from 1988 through 2008 in real dollars investment here means the procurement accounts Which is the bottom portion the purple that does not imply. It's all joint On the research and development accounts the dotted black line across the top is the percentage those investment accounts reflect of the overall DoD budget and that percentage doesn't change all that much if you will in fact If you follow it all the way over to the right hand side where it joins the 2008 32 percent of the doD budget in 2008 was in the investment accounts at the start all the way over on the left It was only 35 percent at its peak at its low point. It went down to about 28 percent if you will So as a percentage investment accounts are only 3 percent lower today or in 2008 than they were in 1988 And in fact in real dollar value rnd is a little bit higher procurement is a little bit lower What do we get for that? These are the major procurement of of Some selected platforms through that process and here for the first time I've actually added a third year 1998 in the middle so you can kind of see the trough and then the come back up if you will you see a range of impacts We bought a lot in 1988 a lot fewer in 1998 Somewhat more in 2008 in some cases like army helicopters, which is on the left We bought almost as many in 2008 as we did in 1988 but very few in between In other cases navy and air force tactical aviation, which is the second and third set of bars over 2008 levels are not much higher than 1998 levels were In still other cases warships and airlift the next two We've got a pretty steady decline between 88 and 98 and 2008 although somewhat less dramatic And then finally on the far right the army ground combat vehicles. There's a lot of growth by 2008 But if you take out m wraps, which is reflected in there, we're actually well below 1988 levels So overall then that 32 percent of the defense budget that constitutes investment Does not buy nearly as many platforms as the 35% did in 1988. There are a lot of reasons for that That's not what we're here to cover today, but the end result is clear We're not getting as many platforms for the money Now it's useful to remember who builds those platforms the defense industrial base in 2008 There were seven major airframe manufacturers today. There are two. Let's look at the ways in which that market has shrunk You don't really need to pay that much attention to the specific Companies inside the boxes. What this shows you is in 1988 There were seven pure us defense companies in the fortune 100 in 2008. There were three All right in 1988 they accounted for 4.4 of the fortune 100 revenue by 2008 They accounted for one and a half percent of the revenue. It's a it's not only a smaller industry It's a much smaller element of our national economy By 2010 there was a fourth one back on here. Raytheon had climbed back into the fortune 100 But everything here I have in 2008. So so there are fewer large defense players on the fortune 100 list And their share of revenue is less than half of what it was in 1988 This is due in part to two big changes First companies that were both commercial and defense tended to sell their defense units Only Boeing really remains of the u.s. Companies that are mixed if you will Second pure defense firms merged and consolidated following the 1993 last supper So the seven that were there in 1988 are all still there in 2008, but they're only half the half the companies So how is industry doing this chart represents two ways of looking at the balance sheet of just those pure defense fortune 100 companies The dotted red line shows the debt ratio of those companies every year from 1988 through 2010 Which is the far right hand side the debt ratio of course is the ratio of total debt to total assets The solid blue line shows the cash ratio of the same set of companies cash ratio is of course the ratio of cash And cash equivalents to current liabilities This means that the larger defense firms today are less leveraged And more cash rich and their balance sheets are stronger than essentially at any time in the last 20 years So they're they are positioned to be able to respond to a potential future The main question is how do they prepare for the coming drawdown? What do they do with that money? Well, we just showed about two charts earlier That the defense department is not likely to be buying as many items as they were in the past So investing in a declining market is not all that attractive an option Defense also came out in February and said oh by the way, you can't buy each other All right, so you may have a last supper, but somebody other than the apostles have to attend All right, so what do we do? Well, one of their options if they can't buy one another is to buy others But as we see here, they've sort of already done that You don't actually need to try to read the names of the companies This is basically the mergers and consolidations that produced in the last 20 years the four companies that you see reflected on the screen here So the lesson of that is in the previous down cycle The defense contractors grew their revenue and their market share through mergers and acquisitions and a lot of that was financed with debt We believe conditions today do not indicate a repeat of that trend And in fact, it's possible that it may go in the opposite direction But what's clear is the defense companies and the market is waiting for clear demand signals from the government before deciding how to use their cash So where does that leave us and now The fun part about my role here is I get to ask the questions and then I get to turn it over to our panel to come up with the answers So going forward, where do we cut this time? Defense budgets are coming down The inventory is older and smaller. That's our top little yellow bar there. It shows a average age of inventory is up So how long can we live off of it before we have to build it back? The budget's grown over the last decade, but the percentage dedicated to procurement is down The third little yellow bar there defense budget has grown, but the share devoted to procurement is negative so Can we do what we did in the 1990s and cut procurement further or will that cause problems for future forces and capabilities We've closed bases. You can see the major bases down We've brought forces back from europe and elsewhere, but Can we close more bases now bring home more troops? What other personnel and other related costs can be reduced Industry consolidated last time. Can we consolidate industry further and what does that mean?