Monday, September 20, 2010

Profit, Loss, and Proliferation

What’s a Weapons Exporter to Do?

by Molly Cernicek and Cheryl Rofer

The two of us have been considering the arms trade, particularly the nuclear arms trade, in the light of economics. We want to try to understand how economic factors may influence nuclear proliferation. The conventional arms trade is a possible model.

The international arms market has slowed in the aftermath of the financial crisis, states a recent CRS report. It "concluded that the value of worldwide arms deals in 2009 was US$57.5 billion, a drop of 8.5 percent from 2008," the New York Times said last Sunday.

The United States continues to be the largest exporter of arms, far outperforming Russia, a distant second at $10.4 billion. "For 2009, the United States signed arms deals worth $22.6 billion -- a dominating 39 percent of the worldwide market. Even so, that sales figure was down from $38.1 billion in 2008." The decline "was caused by a pause in major orders from clients in the Middle East and Asia, which had pumped up the value of contracts the year before. At the same time, there were fewer support and services contracts signed with American defense firms last year."

A 40 percent decline in any market in one year is something that makes stockholders groan and investors clutch their wallets. Perhaps the market will bounce back with more contracts like that proposed by Saudi Arabia, a $60 billion, 10-year-contract with US defense contractors to upgrade its air force. And that upgrade might spur its neighbors to do the same. But then again, what if it doesn’t? What if the weapons market is saturated for the foreseeable future? What if weapons buyers are holding on to their weapons a year or two longer and spending on maintenance and upgrades only, foregoing the latest, shiny models?

Top weapons producers must be looking for new markets just in case the demand for new planes, big guns, and armor continues to slide south. There are only so many customers in the world who can pay with either cash or energy. Governments that don’t have oil may want weapons, but they need loans from governments of arms-producing companies which may be decreasing because of the slower global economy.

More weapons producers are competing than in the past. China is transitioning from being one of the biggest weapons importers of the last decade to exporting its own. With huge political pressure to export as much as possible to feed their voracious economy, China’s weapons suppliers will continue to chip away at this soft global market.

Whatever new customers are in the market may not consider buying from American companies. Russia has invested billions since 2000 to modernize its military and its weapons industry, but with disappointing results. Russia plans to purchase up to four Mistral class amphibious assault ships from France over the next few years, but still will be trying to gain more of the global weapons market.

So, what’s a nail-biting American defense contractor to do? Build new markets. With a finite number of customers for their current line of weapons, they have to look at expanding their product line and then convince their customers that they need these products. What are some of the new hot areas?
* High-tech intelligence equipment, including software and hardware to protect against cyber warfare.
* Guided missile and space vehicle manufacturing for Ground-based Midcourse Defense (GMD) and counter-terrorism.
* Military simulation and virtual training technologies.

Expect to see the bigger defense contractors gain new capabilities through acquisitions and initiatives. Boeing has recently acquired Argon ST and Narus, companies working in intelligence equipment production and cyber warfare solutions. Boeing and Northrop Grumman have teamed up to work jointly GMD for the U.S. Missile Defense Agency. Boeing is still waiting to hear on the long-delayed $35 billion contract to build aerial tankers for the US Air Force.

The Pentagon won’t have much of a chance to pursue a budget reductions if US defense contractors face continued losses in the international arms industry. Their manufacturing capabilities represent jobs, and the contractors have long known that spreading these capabilities across as many states as possible ensure Congressional support.

So we are hearing about the grave threats that cyber warfare poses. In the latest issue of Foreign Affairs, William Lynn tells a scare story about an infection of defense computers that could have been prevented with a good antivirus program or the ever-reliable air gap. Republicans insist on more missile defense, Senator Jim DeMint’s unsuccessful attempt to modify the New START Treaty only the latest example.

We can expect to hear more about these threats.Unfortunately, the products directed toward them will appeal to fewer customers than conventional weapons do, thus putting more pressure on the US government to buy most of the latest gadgets and services.

While China increases its arms production, it is also increasing its role in alternative energies. France is also developing alternative-energy capability. If the arms market is indeed saturated, this may be a wise move that the United States should emulate.

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