GDP and defense: Who’s to blame

There is a flurry in the dovecote today about the decline in the GDP registered in the fourth quarter last year. Is defense spending decline the culprit, we are asked? Indeed defense consumption spending (buying things, not paying people) declined 22 percent in the fourth quarter of the year, the largest single element in an overall decline in federal consumption spending. And doesn’t that say we shouldn’t let sequester happen or, above all, cut the defense budget?

Not so fast. There may be less here than meets the eye. After all, there is an historical pattern here. Every third quarter of the calendar year (which is the last quarter of the federal fiscal year) defense consumption goes up. Obligating and spending resources at the end of a fiscal year is a way of ensuring the services can get them spent and that they can justify the next year’s budget to Congress: we really needed that money; don’t take it back or cut us next year.

Then, in the first quarter of the next fiscal year (which is the fourth quarter of the calendar year) defense spending slides from the leap upward in the previous quarter. Time to catch the Pentagon’s breath, reset spending, and start again.

There is nothing new to this pattern. The Commerce Department data make it clear that this happens during the last two quarters of every fiscal year.

But this year it was a higher jump at the end of FY 2012 and a deeper slide at the start of FY 2013 than in previous years. Why? I believe the answer is partly that the Pentagon is anticipating a decline in resources (and so husbanding money) and partly that the defense draw-down has actually begun.

The concern about the budget this year is only partly about sequester, which everyone seems to think is going to happen March 1. The real focus now is on funding levels for FY 2013, which are currently set at FY 2012 levels in the Continuing Resolution. The military services are worried that this may end up being the budget level for the rest of the year, which is below their budget request. Congress has begun to mark up appropriations bills for defense that are actually $11 billion higher than the cap set in the 2011 Budget Control Act, but a negotiation is likely to bring that level down. It could be that DOD is slowing the spending train to protect resources that will be needed deeper into the year.

The defense draw-down may be playing a role, too. For the past three years the Overseas Contingency Operations account has been falling. It funded a lot of services contractors that provided everything from guards to maintenance to food in Iraq and Afghanistan. Those contractors are already noticing a decline in business, which is accelerating with the move out of Afghanistan.

And one of the foci of the "efficiencies" Secretary Gates pushed a couple of years ago was to deeply cut services contracting in general at the Pentagon. There have already been reductions in the rate at which the Pentagon hires people to sit at desks as if they were government employees, when they are actually employed by private contractors.

We have been seeing a draw-down at DOD for three budgets, now, and are down 10 percent in constant dollars below the FY 2010 peak. So it would not surprise me to see those cuts start to show up in the Commerce Department’s data.

The argument about the GDP decline is a bigger one, with lots of explanations and answers. Clearly DOD spending plays a role in the economy, though it has been shrinking over the years. The ups and downs of the data will continue, as the draw down moves ahead. The worst answer, however, would be to spend unnecessarily on defense as a form of stimulus.