Looking ahead on the soaring U.S. defense industry

Looking ahead on the soaring U.S. defense industry

The U.S. defense industry is performing notably well in 2016, exceeding both the historical trend of the past five years and already upbeat forecasts. Will the year continue as strongly as it began?

As foreign policy experts continue to assess the impacts of U.S. “fatigue” for extended engagement in the world’s foremost military conflicts, a surging U.S. defense industry may seem to be a counterintuitive prospect.

Positive drivers for the U.S. defense industry

There are three major opportunities and drivers that will bolster the growth of the U.S. defense industry in the short-term.

First and foremost, the defense industry as a whole has the unfortunate distinction of thriving when geopolitical conflicts turn violent. Today, the world is facing growing warfare in the Middle East and Africa, escalating military feuds on land and at sea in Asia, and ongoing worries of a bellicose Russia.

These conflicts have been around for years, and they are almost certain to go unresolved within the next 12 months. More importantly, it appears that the gap between impetus and action has finally caught up with world military leaders, as global military spending increased last year after four years of decline.

This year, several of the largest importers of U.S. arms are raising their military expenditures as well. The increases are a signal that greater demand will meet U.S. defense companies in 2016, a fact already being realized by the $29 billion in U.S. foreign arms sales since January.

In addition, the Defense Department recently announced the expected opening of an entirely new market for U.S. defense firms to access: Vietnam. Washington’s former adversary has increased its arms imports by 699% in the past five years, and is recognized as the East Asian country most actively working to counter Chinese efforts in the South China sea.

Now, with the likely removal of a decades old ban on lethal arms exports, Vietnamese interest in U.S. military equipment is expected to be high—contributing to investor interest and industry growth.

Source : Department of Defense

Source : Department of Defense

Finally, the 2016 U.S. defense budget has increased modestly for the first time in several years, and the upcoming presidential election holds the potential to bring continued good news to stakeholders in the U.S. defense industry.

With the pairing all-but-guaranteed to be a showdown between Hillary Clinton and Donald Trump, the early odds are in favor of Clinton—a Democrat who is widely understood as more hawkish than President Obama.

Thus, while the outcome is far away and subject to change, the odds of the U.S. presidential election currently favr future investments in domestic defense manufacturers.

Negative factors for the US defense industry

In spite of numerous positive trends for defense companies in the United States, 2016 also presents several risks for the industry.

To start, Saudi Arabia—the single largest importer of U.S. arms and defense equipment—has recently announced its “Saudi Vision 2030” plan aimed at rapidly establishing its own defense industry and increasing the domestic share of military purchases from 3% to 50% by 2030.

While building a defense industry is a long-term policy that will take years to impact U.S. military sales to Saudi Arabia, U.S.-Saudi relations have within the past month reached new lows, and wary investor speculation may impact the industry long before Saudi Arabia becomes a major self-supplier. Further deterioration of ties with Riyadh—a clear possibility in the context of recent disputes—could accelerate the Saudi departure from U.S. defense suppliers and have negative impacts for investment now.

In addition, if Washington continues its careful diplomatic opening with Iran in venues beyond nuclear policy, other major Middle Eastern importers of U.S. military supplies may be more emboldened to seek arms from other countries.

Another hindrance to continued prosperity in the U.S. defense industry is the increasingly pressing need for reform in how foreign military sales are processed. The procedure—which in the past few years has faced growing criticism from foreign diplomats, Pentagon officials, and defense executives for being overly bureaucratic—is in part responsible for the now two-year delay of a multi-billion dollar fighter-jet contract with Qatar.

With interest in U.S. arms sales growing, cumbersome export protocols will only limit the opportunities of the defense industry in 2016. Unfortunately, mounting calls for reform are not being met with a comparable interest from the U.S. Congress for the 2016 agenda, and streamlining is unlikely until at least 2017.

Uncertainties from the “Trump” Factor

In addition to clear opportunities and risks, the American defense industry will also be subject to unknowns in 2016 that could impact investment prospects for better or worse.

For one, declining oil prices were largely expected to restrict the business of U.S. defense companies throughout the year. While this hindrance never seemed to impose the negative impacts expected, and though oil prices now appear to be in recovery, the volatility of the oil market could still bring detriment to U.S. foreign arms sales.

Furthermore, few industries outside the defense sector offer products for which federal demand has such a high impact on growth. In turn, the “Trump factor”—that is, the relative uncertainty brought about by a potential Donald Trump victory in this November’s presidential elections—has a large impact on the future of the defense industry.

On one hand, Trump has approached security challenges such as ISIS with strong-handed rhetoric that suggests he may follow the standard Republican norm of increased defense spending. This would fuel domestic industry growth.

On the other, Trump has noted that he plans to carry out his assertive military strategy “for less,” and has also called for reducing or eliminating support for crucial security alliances with Europe, Japan, and South Korea.

This may result in a slowing of the U.S. defense industry as investors and major defense companies begin basing their calculations on the assumption of a smaller U.S. military. Yet, it might also lead to an industry-wide boom as countries formerly protected by U.S. assurances seek out premier U.S. military equipment manufacturers to begin facilitating their own self-defense.

Trump has exhibited repeated inconsistencies in his political stances that significantly deter the value of projections—even if he does announce more concrete military plans.

Until November, conflict-driven demand and emerging arms markets will ultimately outweigh the risks presented by tensions with Middle Eastern importers and overbearing export procedures—though these risks are more problematic in the long-term. Even after the election, the odds favor that the defense industry will not suffer regardless of who wins. All things considered, the milestones met last week by major U.S. defense companies symbolize a positive industry outlook for 2016.

Categories: Economics, North America

About Author

Ian Armstrong

Ian Armstrong is Commissioning Editor and Senior Analyst at GRI. He also serves as the Geostrategy and Diplomacy Fellow at Young Professionals in Foreign Policy. Previously, Ian assisted in research at Temple University, the University of Pennsylvania, Scottish Parliament, and Hudson Institute's Center for Political-Military Analysis, where he has focused on non-proliferation and international energy. Ian's analysis has been featured at prominent outlets such as Huffington Post, Business Insider, Foreign Policy Association, CBS News, and RealClearEnergy.