Major Industry Trends
Defense Spending and the Global Economic Downturn
Defense spending is clearly the key determinant of the health of the defense industry. It is sensitive to the economic cycle, with democratically elected governments preferring to focus their resources on politically sensitive areas, such as healthcare and welfare spending, or on measures to boost employment, when their revenues come under pressure during an economic slowdown. Plainly, however, when a country is at war it has little option but to maintain defense spending, regardless of the economic circumstances, and no country is willing to sacrifice its long-term security for the sake of short-term savings.
Military budgets have proven buoyant over the past few years, driven by the wars in Iraq and Afghanistan, and higher spending by developing countries. However, the global downturn was sufficiently severe to cause a slowdown in world military expenditure through 2010, according to the latest figures available from the Stockholm-based peace institute, SIPRI. “World military expenditure is estimated to have been US$1630 billion in 2010, an increase of 1.3% in real terms. This represents the slowest annual rate of increase since the surge in global military expenditure that began after 2001. Between 2001 and 2009, the annual increase averaged 5.1% in real terms,” SIPRI says.
The increase in 2010 is almost entirely down to the United States, which accounted for US$19.6 billion of the US$20.6 billion real-terms increase. Excluding that, the total in the “rest of the world” barely changed in 2010, increasing by a statistically insignificant 0.1%. SIPRI points out, however, that there were wide regional variations. Military spending in South America increased by 5.8% and in Africa by 5%, while Europe actually saw a decrease in military spending of 2.8%. Increases in the Middle East, Asia, and Oceania were modest at around 1.4%.
SIPRI points out that in many cases the falls (or slower increases) represent a delayed reaction to the crisis, with central and eastern Europe making substantial cuts in their military spending and the United Kingdom cutting billions off its defense budget. The United States and China still top the spending league tables, with the United States spending US$698 billion on defense in 2010, up 2.8% on the 2009 figure, and China spending an estimated US$119 million, an increase of 3.8%. France, the fourth-highest spender in the SIPRI league table, actually cut its military budget by a whopping 8.4%.
In early June the US House of Representatives voted through a US$649 billion defense spending bill for fiscal 2012, which begins on October 1, 2011. This constitutes an increase over 2011 levels of US$17 billion. According to Reuters, the House cut some US$8 billion from President Obama’s overall defense spending request as part of the hunt to find ways of slashing the US$1.4 trillion deficit. It voted through US$530 billion as the primary budget for the Pentagon, with a further US$119 billion earmarked for the wars in Afghanistan and Iraq. The House bill does not cover funds for the US nuclear weapons programs or military construction, which adds a further US$33 billion to overall military spending.
In general, countries have difficulty cutting their defense spending by significant amounts in the short term. Defense programs can last for decades, and, if a project is already underway, it is often difficult for a government to cancel its order. Defense spending can also be politically sensitive. Cutting back on equipment orders may simply add to unemployment during a recession.
The United States is by far the largest market for defense equipment, and is likely to remain so for the foreseeable future. Even with a built-in assumption that the wars in Iraq and Afghanistan will be concluded before 2015, US defense spending in that year is still projected to be at a higher level, adjusted for inflation, than in any year in the entire post-World War II period prior to 2005. The United States spends almost as much on defense as every other country in the world combined. In 2015, spending on defense and other “security” activities will take up close to 20% of the federal budget. However, the United States has been taking the axe to many programs as the Obama administration curbs defense spending, which doubled during the Bush years. Among them are the costly F-22 fighter plane, a new communications satellite, shipbuilding programs, and missile development.
The need to cut its massive deficit has prompted swinging cuts in the UK defense budget. However, analysts are warning that the United Kingdom is going to have to choose between continuing a high-profile military and diplomatic role, or winding back its military expenditure. In 2011 an agreement between the Treasury and the Ministry of Defense found an additional £1 billion to fund the costs of Britain’s participation in Libya and Afghanistan, but military chiefs are warning that the UK armed forces are stretched to breaking under the current budget constraints. The issue of how much military spending is too much is going to prove a tough one for the United Kingdom for years to come. Back in March 2010, the UK Public Accounts Committee, a group of lawmakers who examine government budgeting, said that the defense budget was unaffordable and could add £36 billion (US$50 billion) more than expected to Britain’s public debt over the next decade, unless contracts are cut and military costs are more carefully controlled.
Market Analysis
Arms Race Developing in the Asia-Pacific Region
Many analysts believe that growing friction between the United States and China will define the coming decades. Certainly, China is in the midst of an ambitious bid to modernize its military by the middle of this century. A key part of this effort is to downsize its army—the world’s largest—while beefing up its air force and navy. This will enable China to project military force farther beyond its borders.
China’s total spending is second only to that of the United States, but it is low as measured by per capita spending. However, China has expanded its military spending at a double-digit pace in the past decade, and it became the world’s second-largest military power, surpassing France, in 2009. In March 2011, the Chinese government announced that it would be raising its official military budget by 12.7%, to US$91.5 billion. This marks a surge forward in military spending and reverses the government’s 2010 position, when it reined in military spending to a mere 7.5% increase. The 2010 military budget was the first to fall below 10% since 1989. Military experts in the United States and elsewhere have said Beijing’s real military spending is at least double the announced figure. A 2009 Pentagon report estimated China’s total military spending to be between US$105 billion and US$150 billion. While growing rapidly, China’s military spending is still dwarfed by that of the United States.
Something of an arms race also appears to be developing in Asia. In March 2009, the Singapore Straits Times reported that Asia is expected to outstrip the rest of the world in defense spending within seven years, as China and India upgrade their armed forces. The newspaper quoted the findings of Frost & Sullivan. The research consultancy had predicted that Asia’s overall defense budget would account for 32% of global military spending by 2016, or US$480 billion, up from 24% in 2007, while North America’s share of spending would fall from 39% to 29%.
China clearly now intends to develop a military capability to match its new-found economic status and is spending more on its navy and air force and cutting back on its land forces. The idea is to put the country in a better position to project force outside its own borders. China’s insatiable appetite for raw materials and energy has also widened the military’s mission to protect China’s strategic economic interests overseas. The country’s naval and air forces certainly appear determined to impose their dominance in the South China Sea—through which vital oil supplies pass, and where several islands are in dispute—and in the East China Sea, where China and Japan are in dispute over mineral rights, and a number of contested islands.
China has denied claims that it “hides” defense spending, and argues that its military spending is not excessive. It says that defense expenditure would amount to 6.3% of its total budget in 2009, and 1.4% of GDP, compared with 4% in the United States and 2% in the United Kingdom and France. The government says that most of the increased expenditure is focused on improving the historically poor living conditions of soldiers in the People’s Liberation Army. In addition, the authorities intend to increase spending on “informatization,” in an attempt to close the gap on the United States’s use of “smart” technology. Defense companies in the West could benefit from China’s attempts to upgrade its military technology, although it is extremely doubtful whether Washington would allow American companies to supply technology to China.
Some analysts contend that if China’s economic growth remains robust, and the country is thus able to continue to expand its defense spending significantly each year, it will pose a threat to the United States’s military dominance of the globe by the mid-21st century, or earlier. In early 2009, Beijing confirmed plans to build aircraft carriers, with the apparent intent of projecting “blue water” naval power eastwards into the Pacific, bringing it into potential conflict with the United States. For its part, Beijing fears that the United States is trying to “encircle” China, by using India, and allies such as Japan and Australia, as proxies to contain China’s increasing military strength. China’s concerns have some validity—military ties between Washington and New Delhi, for example, are growing in a number of areas.
India is also growing into a major purchaser of US military equipment, an about-turn for a country that relied on Soviet weapons during the Cold War. In a groundbreaking deal, India agreed to buy six Lockheed C-130J transport planes for around US$1 billion in January 2008—New Delhi had previously procured transport aircraft from the USSR or Russia.
India is expected to spend US$100 billion in the next decade on its military. India’s Defense Minister, Arackaparambil Kurian Antony, said in 2010 that he expects military spending, currently 2.5% of GDP, to increase substantially as the nation’s robust economy continues to grow. Boeing is among several companies competing to replace India’s aging fleet of Russian-made MiG-21 fighter jets with a newer system. India is expected to choose a supplier in the first half of 2011, and the purchase of 126 jets is potentially worth US$11 billion. Boeing’s F/A-18 is up against Lockheed Martin’s F-16, the MiG-35 fighter from Russia, the French Rafale (Dassault Aviation), the Swedish JAS-39 Gripen (SAAB), and the European Eurofighter Typhoon (EADS).
Other Major Trends
The Environment
It might appear surprising, but the US military is arguably doing more to save the planet than any other organization on Earth. The US Defense Department is investing huge sums in the search to develop renewable sources of energy, as well as improving energy efficiency. The key drivers behind this trend include: national security—the United States does not want to be dependent upon energy imported from politically unstable regions; cost reasons—even a 5% cut in the fuel bill would save the Department of Defense US$635 million (based on the 2007 figure); and, finally, because it makes sound military sense—many lives are lost transporting fuel to the front line in vulnerable convoys.
The US military is already one of the largest consumers of renewable energy in the world, and it has set a goal that 25% of its energy should come from renewable sources by 2025. The US Air Force’s goal is that 50% of all the fuels used in domestic training flights will come from synthetic, or non-petroleum, sources by 2016. The US military is also investing heavily in solar and wind power.
Technological Advances
The military is one of the key drivers of technological advances. There are certainly some remarkable developments taking place. The F-35 Joint Strike Fighter, being developed by Lockheed Martin, Northrop Grumman, and BAE Systems, for example, features some extraordinary features. These include technology that allows the pilot to look through the structure of the aircraft. The aircraft also features voice commands that significantly reduce the pilot’s workload.
The military is also investing heavily in information technology on land. Military units constantly transmit huge amounts of data back and forth to report their position, generate situational awareness, and share information on enemy tactics. Soldiers with access to laptops, for example, can provide vital information to military commanders. Real-time management of information enables rapid decision-making, meaning that military operations can proceed quickly, possibly providing a decisive advantage during a battle.
Cyberspace: The New Battlefield
Unsurprisingly, given the new emphasis on information technology, governments around the world are investing heavily in measures to protect their computer networks from attacks, and to launch their own cyber attacks. In January 2010, the Guardian reported that the Chinese military has been developing capabilities to spy on, infiltrate, and compromise adversaries’ computer networks for years. “Informatized war” is an integral component of its “three warfares” (san zhong zhanfa) strategic concept, and the achievement of information superiority is viewed as a requirement for battlefield supremacy. Many large defense companies have already branched out into cyber-security and information-technology services.
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