Opinion: Defense Is Unscathed By COVID-19? Think Again.
The rapid onset of the novel coronavirus has wreaked havoc on markets around the world, hitting commercial aviation especially hard as load factors plummet, flights are canceled and suppliers cut production rates and furlough workers. Amid all this disruption, defense manufacturers appear to have been relatively unscathed. But defense has always been a long-cycle business, driven more by annual budgets than daily load factors. And as the bill for rebuilding the global economy mounts, defense budgets are sure to come under pressure.
COVID-19 is first and foremost a human tragedy, and its continued spread is still a major concern. But we must solve for both the virus and the economy; the dual imperative of our time is the desire to preserve lives and livelihoods. Both will require substantial resources for public health and for economic rejuvenation. Countries around the world are making massive investments to rebuild battered economies, putting out more than $11 trillion in the last 2.5 months, with more sure to follow.
In the U.S., Congress passed the $2.2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act at the end of March, bringing the total stimulus thus far to $3 trillion, which could push the fiscal 2020 budget deficit to a record $3.8 trillion, an eye-watering 18.7% of the country’s GDP. Other countries have passed similar aid packages, leading to soaring debt levels around the world. And more may well be necessary: The House has passed proposals for another $3 trillion in aid, although the bill’s fate in the Senate is unclear.
Government debt levels are already high, swelling as the global financial crisis of 2008 caused a drop in tax revenues and a rise in social-safety-net payments. And the wave of deleveraging many expected as the recession eased never materialized: From 2008 to mid-2017, global government debt more than doubled, reaching $60 trillion. According to the International Monetary Fund (IMF), this year’s increase in public-sector debt has reached 122.4% of gross domestic product (GDP) on average in developed countries.
Increased deficits worldwide are likely to put pressure on all discretionary spend, including defense. In the U.S., military spending accounts for 15% of all federal and roughly half of discretionary spending, so defense may come under real pressure. Rep. Ken Calvert of California, the ranking Republican on the House Appropriations defense subcommittee, says defense budgets were strained even before this year’s unplanned burst of deficit spending. “There’s no question that budgetary pressure will only increase now for all segments of our federal budget, including defense,” Calvert said. Defense Secretary Mark Esper has said he is preparing for future defense budget cuts and that legacy systems may need to be scrapped to pay for more modern forces.
South Korea shows early signs of this trend, with leaders recently announcing a shift in resources to disaster relief in response to the pandemic. Money came from education, agriculture, and environmental protection but mostly from defense. This example is particularly significant, given that South Korea is still technically at war, frozen in conflict with its immediate neighbor to the north. Furthermore, South Korea has been more effective than its peers in addressing the pandemic with a swift medical response and widespread testing that allowed the country to reopen its economy faster than other advanced countries. If South Korea is altering its budgetary priorities, others could follow.
The coronavirus has already had a massive human cost, resulting in approximately 300,000 deaths, including more than 90,000 Americans, more than were killed in Vietnam, the Gulf War, Iraq and Afghanistan combined. But the financial cost has been even greater. The cost in the US has already exceeded that of all the wars the U.S. has fought over the last 50 years. And if an additional $3 trillion is approved by Congress, the cost will surpass that of World War II.
At this point, it is too early to predict how much the defense budget will draw down how quickly. Indeed, the shift might not occur immediately. Broadly speaking, two factors have historically had the most influence on defense spending: threats and affordability. Governments will all calibrate the relative importance of the threats they face against their new economic realities. In keeping with past patterns, countries may give most weight to threats, real or perceived, over the near term. If there are anticipated or ongoing conflicts, their defense budgets will probably increase. Over the longer term, however, economic factors tend to prevail, and governments may set defense budgets in line with their diminished resources. Either way, we face some tough decisions ahead.
John Dowdy is a senior partner at McKinsey & Co. He is based in London.
The views expressed are not necessarily those of Aviation Week.