Today I’m writing about an astonishing report that came from the Pentagon this week on how Wall Street has wrecked the defense industrial base. This chart, which shows stock buybacks are up while research and development is down, is the key finding.
From Javelins to ordinary ammunition to ship repair to ball bearings, the U.S. military just can’t get what it needs.
I’ve been writing about the defense industrial base monopoly problem for years at this point; the first major piece[1] I did was in the American Conservative in 2019. The modern story is relatively simple. In the 1990s post-Cold War era, the White House sought to cut defense spending. Bill Clinton’s administration arranged a deal with defense contractors; they would tolerate lower revenue or stagnant revenue, if they got higher margins. And so at a dinner known as ‘The Last Supper’ held in the Pentagon, the Clinton Defense Department encouraged a merger wave. Throughout the 1990s, the DOD even paid the merger costs of its defense base firms; the number of major prime contractors (or ‘primes’) dropped from dozens to 5. In addition, Congress, under ‘Reinventing Government,’ passed laws to eliminate contracting rules that blocked price gouging of the treasury.
All of this monopolization was done in a unipolar moment, when just-in-time manufacturing where suppliers kept no inventory on hand was applied to everything, even military stockpiles. This was, in retrospect, insane. Who thinks that having no resiliency is a good strategy for wars?
Since Covid and increasingly during the Ukraine conflict, policymakers have realized the U.S. faces real physical constraints on what we can build. Consider that the U.S. still cannot replenish its stocks of Javelin and Stinger missiles. Why? Not because the money isn’t there, but because if defense contractors act too quickly, they would, as one consultant to the industry put it, “get hammered by Wall Street.” And since there’s virtually no competition at this point in building any weapon major system, there’s no rush to take market share.
The DOD tasked three universities with examining how Pentagon contracting works, and did an internal analysis, all to determine the financial health of the defense base. And what they found is not so different than health care, big tech, finance, or any other industry segment; defense is run by a few giant middlemen who do exceptionally well by shareholders, outperforming commercial rivals and the S&P index. Contracting doesn’t look especially profitable, but the relatively lower margins are more than compensated by a host of favorable contracting terms offered by the government.
[1] When Wall Street targeted the commercial industrial base in the 1990s, the same financial trends shifted the defense industry. Well before any of the more recent conflicts, financial pressure led to a change in focus for many in the defense industry—from technological engineering to balance sheet engineering. The result is that some of the biggest names in the industry have never created any defense product. Instead of innovating new technology to support our national security, they innovate new ways of creating monopolies to take advantage of it.
A good example is a company called TransDigm. While TransDigm presents itself as a designer and producer of aerospace products, it can more accurately be described as a designer of monopolies. TransDigm began as a private equity firm, a type of investment business, in 1993. Its mission, per its earnings call, is to give “private equity-like returns” to shareholders, returns that are much higher than the stock market or other standard investment vehicles.
It achieves these returns for its shareholders by buying up companies that are sole or single-source suppliers of obscure airplane parts that the government needs, and then increasing prices by as much as eight times the original amount. If the government balks at paying, TransDigm has no qualms daring the military to risk its mission and its crew by not buying the parts.
