Mad procurement rules help explain why defence spending is so hard to cut

Mad procurement rules help explain why defence spending is so hard to cut

Mar 1st 2014 | From the print edition

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AT THEIR factory in Big Rapids, Michigan, workers at Bates, a maker of military boots and shoes, can see geopolitical trends unfold before their eyes. Straight after the September 2001 terror attacks on America, the firm moved to round-the-clock shifts. The black leather boots of the cold war and its aftermath gave way to shades of beige and tan: hot-weather boots for marines, desert footwear for the infantry, mountain gear for special forces. Today the plant is evolving once more. If procurement orders are any guide, American commanders are bracing themselves for conflicts in any number of continents. Staff report much work on jungle boots and discussions of the right shades of leaf-green to use in Asia, Africa or Latin America.

Other trends may be seen in Michigan. A war-weary public likes it when politicians vow that future interventions will avoid large-scale “boots on the ground”. The line resonates differently in a place that actually makes boots for soldiers, in a hot, noisy ballet of cutting, stitching and hammering. As wars have wound down, the plant has shed half its workers since a peak in 2008-09.

On February 24th, a world away in Washington, DC, the defence secretary, Chuck Hagel, made headlines by suggesting that America’s regular army could fall to its smallest size since 1940, as he unveiled a $496 billion draft budget for 2015 that would also add to special forces, while retiring whole classes of ageing aircraft and asking Congress to consider closing unneeded bases. Noting that personnel costs consume about half the Pentagon’s budget, Mr Hagel suggested modest tweaks to military pay, allowances and benefits, after large (and understandable) rises throughout the long years of war after 2001.

Yet harnessing austerity to reform the defence budget will be dauntingly hard. Congress will have final say over Mr Hagel’s plans and something about camouflage gear has a strange effect on politicians. Even in this era of cuts, the Pentagon’s budget is vast: America accounts for about four of every ten dollars spent on defence worldwide. The temptation is always there to play at industrial policy or simple favouritism.

The scale and the complexity of Pentagon spending make it hard to assess the real prospects for reform. Lexington headed to snowy western Michigan to ponder how defence spending works on the ground in a single industry. As a case study, military footwear is pretty startling. Boot factories in rich countries are a rarity. Indeed Wolverine Worldwide—the Michigan-based company that owns Bates, along with such civilian brands as Merrell and Hush Puppies—makes almost all its other shoes abroad, where labour costs are 30-40% lower. The plant in Big Rapids is still more unusual: every component used there is American, from leather (a Minnesota tannery provides most hides) to shoelaces, eyelets and the yarn used for linings. This patriotism is explained not by sentiment, but the law. Military footwear is governed by the Berry amendment, passed by Congress on the eve of war in 1941 to ensure that troops would be given home-grown wool and food. Today the amendment applies to most uniforms, tents, flags and processed food bought with Pentagon funds. These must be entirely American-made or -grown, unless domestic firms simply do not make the product.

Fish nuggets, American-style

The rules are far stricter than those that apply to the federal government through the Buy American Act, which smiles on goods once they are more than half American. They are also amazingly complicated. One clause specifies that fish nuggets served to troops must contain only fish caught in American waters or by an American-flagged ship, but may use foreign breadcrumbs.

The amendment’s stated aim is to preserve the industrial base. Yet a bipartisan clutch of senators and members of Congress—notably from states with some domestic shoe production—has spent years prodding the Pentagon to start buying a product that does not exist: all-American military running shoes. Under orders from Congress, defence officials formally asked domestic shoemakers in January to report if they could make “Berry-compliant” athletic shoes. The inquiry was made through gritted teeth. Market forces do a fine job of supplying comfortable, cheap running shoes to recruits. Defence officials argue that costs may rise if trainer choices are limited, and that injuries may even follow. The signals are clear enough: the Pentagon has no desire to get into the sneaker-design business.

In contrast, bosses at the Bates plant are eager to start making all-American military trainers, citing benefits to domestic industry and national security. One Bates executive raises the spectre of conflict with China, suggesting that allowing troops to buy Chinese-made shoes carries “geopolitical” supply risks. A rival firm with plants in Massachusetts and Maine, New Balance, has already bought a machine to make mid-soles, the last running-shoe component that it was buying in from abroad.

It is hard to fault companies for trying to generate new business. Congress’s record is more alarming. In a big break with the past, a cross-party majority of members now seems willing to tolerate lower overall defence spending. But those same politicians still fight to keep Pentagon cash for pet causes, home districts and nods towards protectionism. They are also wary of unpopular reforms. With an eye on mid-term elections in November, Congress recently overturned a tiny change to military retirement benefits after ex-soldiers complained. Members are expected to block talks about base closures. Mr Hagel may even struggle with his plan to trim subsidies for military supermarkets (which at $1.4 billion a year are larger than the defence budget of Hungary).

Europe is mocked for running “heavily armed pension funds” rather than proper armies, as shrinking defence budgets are skewed towards personnel costs and politicised investments. Congress seems bent on pushing America into the same trap.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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