Defense industries ; Federal Reserve District, 12th

Carolyn Sherwood-Call

Kristin Hotti

English

Research Papers in Economics

FRBSF WEEKLY LETTER
March 28, 1986
The Contract Defense Industry in the West
In recent years, the contract defense industry has
contributed significantly to the western econ-
omy. For example, vast infusions ofdefense
monies have placed 41 percent of all aerospace
jobs (many ofwhich are defense-related) in the
five western states that comprise the Pacific
Census region (Alaska, California, Hawaii,
Oregon, and Washington). Furthermore, in fiscal
year (FY) 1985, manufacturers in the Twelfth
Federal Reserve District (Alaska, Arizona, Cal-
ifornia, Hawaii, Idaho, Nevada, Oregon, Utah,
and Washington) received some $37 billion in
prime Department of Defense (DOD) contracts
for research, development, and construction of
major weapons systems, or over 24 percent of
all contracts awarded nationally. California led
the nation in contract awards, receiving about
$29 billion or 19 percentofthe U.S. total.
This Letter examines the role of contract defense
spending in the western economy and the
potential impact of defense spending cuts that
may be instituted to reduce the federal govern-
ment's budget deficit. We conclude that defense
contractors have historically been quite vulner-
able to changes in defense outlays, but the mix-
ture of activities concentrated in the West
should reduce the adverse impact of any such
spending cuts.
Contribution to economic activity
Following the national pattern, manufacturing
employment has declined as a share oftotal
employment in the West over the past few years.
The decline would have been considerably
greater had it not been for strength in defense-
related aerospace manufacturing. Currently in
California, jobs in the aerospace and related
industries account for about 36 percent of all
jobs in manufacturing and almost 7 percent of
the total nonagricultural employment base. In
Washington, aerospace and related employment
makes up 31 percent oftotal manufacturing and
over 5 percent oftotal employment. The indus-
try is relatively less important in other western
states, but still contributes significantly to overall
employmentgrowth.
Many analysts have attempted to measure the
impact of defense spending on regional econo-
mies, although such estimates are generally
regarded as too optimistic. The estimates over-
state the positive effects ofspending increases
because they ignore the taxes or government
borrowing required to fund government spend-
ing. Estimates from various sources, including
the DOD, indicate that each $1 of additional
defense spending generates $1.60 to $2.70 in
additional spending and income. Indeed,
according to some estimates, growth in defense
spending may have been responsible for as
much as 10 to 20 percent oftotal economic
growth in California during 1984. DOD econo-
mists also estimate that each additional $1 bil-
lion in prime contracts directly creates an
additional 7,500 jobs.
Various other studies give a less optimistic view
ofthe job creation potential of defense spend-
ing. They have indicated that a dollar of spend-
ing in the defense industries generates fewer
jobs than the equivalent spending boost in the
non-defense manufacturing sector because
defense expenditures are increasingly aimed at
more capital intensive activities. The importance
of highly specialized, high technology weapons
systems has increased relative to that of conven-
tional military hardware. In 1968, for example,
the aircraft and missile components of aerospace
employment made up over 59 percent ofthe
total. That share now stands at about 30 percent;
computers and electronic equipment account for
the balance.
Today, many of the defense industry's workers
are highly compensated specialists rather than
production workers. Whereas in 1968, produc-
tion workers made up about 53 percent ofthe
aerospace workforce, they made up only about
45 percent in 1985. In missile and space-vehicle
manufacturing, only one-third ofthe workers are
production workers. In contrast, production
workers currently account for about 70 percent
of all employees in the u.s. manufacturing sec-
tor as a whole. Consequently, while defense
contracts contribute significantly to some
regions' economies, the jobs they create directly
may not be accessible to the majority of the
labor force.
Futureinstability?
While defense spending contributes significantlyFRBSF
to regional economic growth, excessive depend-
ence on this source of investment could lead to
future instability. Historically, the aerospace
industry has been extremely vulnerable to dra-
matic dislocations as the volume of defense
spending fluctuated with national policy objec-
tives.
The aerospace sector also has been affected by
cyclical declines in overall economic activity
because commercial aircraft purchases (another
large part ofthe sector) are cyclically sensitive.
From 1965 to 1968, aerospace employment in
the West grew by about 30 percent in conjunc-
tion with the Vietnam arms build-up. Then, as
the volume of contract defense awards fell
between 1968 and 1971 and the economy slip-
ped into recession, employment in the industry
plunged 31 percent. Moderate employment
growth resumed until the 1974-75 recession
again caused great losses. Under the Reagan
Administration's military build-up, western aero-
space employment, shown in the chart, has sky-
rocketed again (by about 17 percent) to a record
high level.
Several regions in the West have reaped the bulk
of benefits from the boom in defense-related
manufacturing and therefore have the most to
lose should major cutbacks in defense spending
occur. Missile and military aircraft production,
the two largest components oftotal military
sales, have been centered near Los Angeles. Los
Angeles County captured about 48 percent of
total 1984 DOD contracts awarded in Califor-
nia, and the Los Angeles/Long Beach area pres-
ently provides an estimated 40 percent of all
jobs in the state's aerospace industry.
The Silicon Valley region in northern Califor-
nia's Santa Clara County has benefitted from the
growing portion of the defense budget allocated
to military electronics. Firms in that area
received about 28 percent ofall the DOD con-
tracts awarded in the state in 1984 - a 19 per-
cent increase from the previous year. Much of
this increase in defense-related spending was
due to huge new contracts awarded to one of
the nation's primary contractors for the Strategic
Defense Initiative, or "Star Wars", project. It is
estimated that defense-related spending now
generates from ten to twenty percent ofthe man-
ufacturing jobs in Santa Clara County.
Employment at the SeattlelTacoma-based Boeing
Company accounts for about 80 percent oftotal
aerospace employment in Washington, and
provides a significant boost to the economy of
the Seattle area. Although defense and space
shipments accounted for only 43 percent of
Boeing's 1984 sales, they accounted for 94 per-
cent of Boeing's pre-tax profits.
The dangers of extreme reliance on defense
spending have been illustrated by the erratic
booms and busts experienced in smaller regions
dominated by the contract defense industry.
Southern California's "Aerospace Valley" near
Palmdale relies on large aerospace operations
for as much as 90 percent of its overall eco-
nomic activity (according to one estimate). Such
lack of diversification has resulted in violent
swings in employment levels.
Other western regions have also experienced
painful dislocations when weapons programs
were canceled or when contracts expired. In the
mid-1960s, employment at one Sacramento
plant fell by 90 percent - from 20,000 to 2,000
- in one year. The history of the Seattle area's
economy has been a prominent example ofthe
sharp swings in activity that can result from
reliance on a single industry. Employment losses
from a dependence on the Boeing Company
were especially severe in the 1970s, and led to
Seattle's diversification away from aerospace.
Outlook for defense spending
The outlook for the contract defense industry
depends critically on the outcome ofthe battle
to reduce the federal budget deficit now under
way in Washington, D.C. On the one hand,
President Reagan is proposing further increases
in military spending. On the other, some mem-
bers of Congress are balking at the prospect, and
have proposed substantial cuts in specific
weapons programs, including some (the Trident
submarine and the Stealth bomber) that are built
principally in the West. If Congress and the Pres"
ident are unable to agree, then the Gramm-Rud-
man-Hollings deficit reduction act will impose
across-the-board expenditure cuts.
Regardless of any Constitutional or other chal-
lenge to Gramm-Rudman-Hollings, as of March
1 defense spending for the remainder of FY 1986
will be cut by $4.9 percent. DOD will loseFurthermore, compared to other regions, the
western aerospace industry may be fairly insu-
lated from defense spending cuts. While DOD
spending on many weapons programs has been
levelling off in recent years,expenditures
allocated to military electronics, in which West-
ern producers specialize, have grown about 15
percent annually. In addition, the Reagan
Administration's FY 1987 budget indicates con-
tinued commitment to programs being
developed primarily in the West. These projects
include SDI, the MX "Peacekeeper" missile, the
Stealth bomber, and the Trident submarine-
launched ballistic missile system. Some ofthese
projects could backfire on the West, however,
because they are also on the list of big-money
items targeted for elimination by some members
ofCongress.
defense industry by the late 1980s, the current
backlog of orders at aerospace manufacturers as
well as unspent federal defense appropriations
left over from previous years ensure high levels
of activity over at least the next two years.
1985 1980
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1975 1970
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1965
60 L-__...L-__-'-__ ----'--__----'-__--'
1960
80
1960 =100
160
140
100
120
Value of Prime Defense Contracts
and Aerospace Employment in the West
about $13.8 biIIion in 1986 budget authority.
This includes a reduction of about $5.4 billion
in outlays for FY 1986; the remainder, $8.4 bil-
lion, will take the form of smaller outlay reduc-
tions in each of the next few years.
The prospects beyond FY 1986 are not at all
clear. DOD projects that the budget for weapons
procurement will decline slightly next year. But
the FY 1987 budget recently submitted by the
Reagan Administration, which complies with the
Gramm-Rudman-Hollings deficit ceiling, calls
for a 3 percent increase in inflation-adjusted
defense spending. According to the provisions of
Gramm-Rudman-Hollings, failure to meet the
stipulated deficit ceiling would trigger automatic
defense outlay cuts estimated at $18.5 billion, or
6.5 percent ofthe projected defense outlays for
FY 1987. A Congressional compromise that
meets the deficit target would likely fall between
these two extremes.
Although slowing the growth of or shrinking
defense appropriations could affect the contract
Summary
While the contract defense industry, fueled by
recent rapid increases in federal defense spend-
ing, contributes significantly to regional eco-
nomic growth, overreliance on this sector could
result in severe economic dislocations. Histor-
ically, contract defense activity has been quite
sensitive to changes in government spending
patterns. Current deficit-reducing proposals,
which affect defense spending, therefore pose a
threat to regional economic growth. Any poten-
tially adverse impact on the West would,
however, be cushioned by this region's domi-
nance in the area of high-technology defense
electronics and perhaps also by its large share of
the Administration's top priority projects.
Kristin Hotti and Carolyn Sherwood-Call
MONETARY POLICY OBJECTIVES FOR 1986
Federal Reserve Chairman Paul Volcker presented a report to the Congress on the Federal
Reserve's monetary policy objectives for 1986 on February 19. The report includes a summary
of the Federal Reserve's monetary policy plans along with a review of economic and financial
developments in 1985 and the economic outlook in 1986. Single or multiple copies ofthe
report can be obtained upon request from the Public Information Department, Federal Reserve
Bank of San Francisco, P.O. Box 7702, San Francisco, CA 94120; phone (415) 974-2246.
Opinionsexpressed in this newsletterdo not necessarily reflect the views ofthe managementofthe Federal Reserve Bank ofSan
Francisco,orofthe Board ofGovernorsofthe Federal Reserve System.
Editorialcommentsmay be addressedtotheeditor(GregoryTong) ortotheauthor....Freecopiesof Federal Reserve publications
can beobtained from the Public Information Department, Federal Reserve Bank ofSan Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.uo~6u!4S0m 4o~n U060JO 0POA0U
040PI !!omoH O!UJoJ!IO) ouoz!Jl:J o~soll:J
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Change from3/6/85
Dollar Percent?
Change
from
Amount
Outstanding
Selected Assets and liabilities
Large Commercial Banks
"l/t;/Rf. 2/2f.1Rf.
Loans, Leases and Investments1 2 202,297 1,587 13,212 6.9
Loans and Leases1 6 183,384 1,726 11,976 6.9
Commercial and Industrial 53,097 448 - 3 - 0.0
Real estate 66,351 53 3,953 6.3
Loans to Individuals 38,446 - 101 5,590 17.0
Leases 5,649 - 23 320 6.0
U.S. Treasury and Agency Securitie~ 10,782 - 64 41 0.3
OtherSecurities2 8,131 - 75 1,194 17.2
Total Deposits 202,463 4,183 8,071 4.1
Demand Deposits 49,627 3,495 4,882 10.9
Demand Deposits Adjusted3 32,659 1,638 3,619 12.4
OtherTransaction Balances4 15,640 873 2,046 15.0
Total Non-Transaction Balances6 137,196 - 184 1,144 0.8
Money Market Deposit
Accounts-Total 45,827 37 1,932 4.4
Time Deposits in Amounts of
$100,000 or more 37,636 - 381 - 1,276 - 3.2
Other Liabilities for Borrowed Monevs 25453 287 7568 42.3
Two WeekAverages
of Dailv Fi2ures
Period ended
2/24/86
Period ended
2/1 0/86
Reserve Position, All Reporting Banks
Excess Reserves (+ljDeficiency(-l
Borrowings
Netfree reserves (+ljNetborrowed(- l
71
191
119
81
10
71
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading account securities
3 Excludes U.S. government and depository institution deposits and cash items
4 ATS, NOW, Super NOWand savings accounts with telephone transfers
S Includes borrowingvia FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annualized percent change

The contract defense industry in the West

http://www.frbsf.org/publications/economics/letter/1986/el86-13.pdf

The contract defense industry in the West

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