Abstract
The US has the largest defense market in the world, and in 2012 the US defense budget stood at US$645.7 billion. Expenditure is primarily driven by the modernization of existing weapon systems as well as the acquisition of advanced defense equipment capable of enhancing interoperability among the armed forces. Due to its high levels of military spending, a large number of opportunities are available to companies keen to supply the nation with defense equipment; however, pressure to reduce the debt burden after the US financial crisis has shown a negative impact on the government budget and caused cuts in defense budget as well. A side effect of the uncertainty and budget cuts in the U.S. is strong industry interest in international sales. Defense companies that have never worked abroad are now eyeing the international market as a way to diversify their sales and balance out volatility in the U.S. market.
The Foreign U.S. Defense Industry: International Arms Sales
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U.S. Defense Industry Flees the Country
Defense budgets peaked in FY 2010 and have been down about 10 percent in the past 2 years. Factor in the budget sequester for this year and the defense budget will have fallen 24 percent from their height during The War on Terror.
The future does not look different. If the sequester remains, one can expect another roughly $500 billion to disappear from projected defense budgets over the next nine years.
Oddly, defense contractors seem to be doing OK, so far. Sales had declined a bit even before sequestration set in, but profit margins are holding strong.
The scope of this paper is to examine how the industry is thriving when domestic demand is declining.

The Current Defense Drawdown
The defense drawdown is now well underway, and the defense industry is starting to pack it up. The US defense industries revenues grew 0.3 percent over the first six months of 2012. In constant dollars, revenue actually shrank. That’s better than 2011, which saw a 3.3 percent decline in the US.
This year’s Budget Control Act cut $487 billion from defense spending over the next 10 years, roughly $50 billion of which is already reflected in the budget for 2013. Since about half of Pentagon spending goes to contractors, that’s about a $25 billion hit to industry — whose annual revenues are only about $210 billion. That’s a 12 percent hit to revenues. If the defense industry’s 724,000-strong workforce takes a proportional blow, that’s 86,000 layoffs.

When the sequestration cuts hit, the cuts to defense doubled. Although it’s easy to be lured into thinking that the industry would be buffered from the near-term impact by work already paid for and in the pipeline from prior years, the uncertainty over sequestration renders this. After all, both managers and investors have to plan ahead and they have to account for the uncomfortably plausible worst-case scenario that the sequester cuts will become permanent.
So between the cuts required last year and the current sequestration cuts looming now, the defense industry will have shrunk by about 25 percent. Oddly, defense contractors seem to be doing OK, so far. Sales had declined a bit even before sequestration set in, but profit margins are holding strong for the big guys -- Lockheed Martin, General Dynamics, Raytheon, Boeing, Northrop Grumman, L3.

The Potemkin village

This apparent fiscal health is actually an economic Potemkin village. Profit margins may hold, but U.S. sales are clearly headed down. The illusion stems from the reality that the major defense contractors are still working on programs funded in previous years, when budgets were higher.
But as the U.S. defense budget heads down, DOD's dollars to buy stuff will drop more quickly than the overall budget, as they have in every drawdown since the Korean War. Between FY 1985 and FY 1998, for example, the defense budget declined 31 percent in constant dollars, while funding for research and purchases of hardware fell 53 percent.

This reality is already apparent today -- budgets for weapons research and acquisition, before the sequester, were already down nearly 20 percent in constant dollars since FY 2010, and, with the sequester, could decline nearly 30 percent.
The industry response to the coming decline began several years ago. Major contractors sold or consolidated business units, entered new markets (largely through acquisitions), and trimmed the workforce. Northrop Grumman, for example, sold its Newport News shipyard in 2011, leading to the creation of an independent business -- Huntington Shipyards.
Boeing is reducing its management workforce by 30 percent and has closed defense production operations in Kansas and California. L-3 sold its consulting and government services businesses (I worked for them during this time). Lockheed Martin already began consolidation and cutbacks in its missile and training operations in 2012. Overall, aerospace industry employment, which grew through the past decade, began a predictable decline in 2012, in advance of any implementation of the sequester.

Where U.S. Defense Contractors Are Winning

While defense spending in the U.S. market may be declining, U.S. defense contractors are set to achieve record overseas sales of $46.1 billion in military hardware to foreign governments this year, almost a 50 percent jump from $31.6 billion last year.
Numerous multibillion-dollar purchases have buoyed the U.S. defense market including sales to India, Saudi Arabia, Egypt and other countries. The result has translating to more defense-related jobs at home.

Who is buying and what’s for sale?
India signed a deal recently to purchase 10 Boeing C-17 military cargo jets, the Boeing C-17 assembly line in Long Beach was planned to be shut down by the end of next year. Now, the plant is scheduled to remain open through 2014. The sales are also good for small, Southern California machine shops that supply parts.
Lockheed hopes its F-35 fighter will have a big export market. It is, after all, being built in partnership with Britain, Turkey, Italy, and Denmark, among other countries, which are expected to buy it -- that was the whole point of cooperative agreements on F-35 development and production. For Lockheed and the U.S. aerospace industry, F-35 international sales are critical. If it sells, it would guarantee a leading position for U.S. firms in the international fighter market for years to come.
Boeing and Bell Helicopter companies are pushing the V-22 VSTOL transport plane into international markets, including Israel and the UAE, with prospects in Britain, France, Canada, Libya, Saudi Arabia, Qatar, Italy, Colombia, Brazil, India, Japan, and Singapore.
Even with defense budgets shrinking globally, the drone market is another prime export target. General Atomics, maker of the Predator and Reaper drones -- which have been on full display overseas in Iraq, Afghanistan, Pakistan, and Yemen, is hoping to push these items into the civilian realm.
Australia desires to purchase two dozen Navy Seahawk helicopters valued at $1.6 billion. Saudi Arabia wants $330 million in thermal-imaging and night-vision equipment and Britain is looking to purchase $137 million in upgrades for its U.S.-made ship-mounted guns. Orders are also in from Morocco, Iraq and the United Arab Emirates.

Pentagon Pushing Sales???
Pentagon leaders are considering designing new weapons that would make it easier for foreign nations to buy them. The Pentagon needs a viable defense industry to supply its weapons and equipment needs over the long term. If the U.S. military can't provide enough business to keep the defense industry solvent, then what might be the next best thing? Increasingly, it looks like the Pentagon is looking to international military forces to pick up the slack. Established allies typically don't have much problem buying from U.S. defense companies. Plans under consideration call for enhanced exportability within development programs, and include one program for a radar and another for an electronic warfare system that will serve as pilots for this effort.

Official Administration Position on Weapon Sales
Administration officials say the boom in arms exports is simply the result of healthy demand. Indeed, American-made arms are widely considered the best and most coveted weapons in the world. But the Obama team has hustled to pave the way for big sales like the Saudi deal; the President himself recently sought to secure a pending $4 billion aircraft deal with India. Obama is also backing a massive push to rewrite the rules that govern arms exports, a process that some say will reduce oversight of U.S. weapons sales.
For the administration, robust international arms sales advance domestic goals, like bolstering exports and supporting a defense workforce of more than 200,000. Weapons transfers are also a subtle yet potent form of diplomacy: By arming its allies, the U.S. can spread the burden of policing hot spots (the Middle East, the Korean peninsula). And arms exports give Obama's State and Defense departments’ tremendous negotiating clout with buyers.

The Double Edge Sword
Supplying some nations with advanced weaponry is a risky strategy, especially as the Middle East, which is teeming with American-made arms and crackles with the sparks of regime change. While the U.S. sells weapons only to its allies, power can shift quickly -- just look at Tunisia and Egypt. Even Saudi Arabia, with its 86-year-old monarch, could see a change in leadership. When friends become foes, arms exports become a liability. The government sold dozens of F-14 fighter jets to Iran in the 1970s before the Shah was deposed. Since then the U.S. has systematically destroyed F-14 parts to keep them out of Iran's hands.
Weapons proliferation watchdogs expected the volume of exports to decline when Obama became President; instead the reverse has happened. This is in large part due to the recession. Production lines for Boeing's F-15, Harpoon missile, and Apache helicopter are sustained by exports, which support thousands of high-paying, highly skilled manufacturing jobs.

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