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The Pentagon and the defense industry are banking that Congress, more likely than not, will fund the president’s 2018 budget request and then some. As they watch the battle lines form over the coming months, they will be drawing clues from Trump’s budget proposal — and especially what it says about Defense Secretary Jim Mattis’ thinking on how he plans to modernize the military.

Analysts warn against extrapolating trends from a single-year budget, as the administration chose not to unveil the five-year plan that the Pentagon typically maps out. Mattis has ordered a strategic review of military requirements that, according to budget documents, will inform long-term spending plans starting in fiscal year 2019.

The budget that President Trump submitted to Congress last week, to be sure, stands zero chance of being enacted. The $639 billion request for the Defense Department is being blasted from both sides, and the final outcome is anyone’s guess. House and Senate budget committees will start to mark up budget resolutions in June. Congress has four months to reach some sort of compromise on spending and taxes, and fund the federal government before the money runs out.

Those caveats aside, the choices revealed in the 2018 budget offer some clear indicators of where the Pentagon is headed, regardless of what top line Congress ends up appropriating. Industry insiders point to several telling items: Procurement is flat (except bombs and missiles, which are up 17 percent), research and science get a 16 percent boost, and space programs are up 23 percent.

These funding choices “jump out,” said Bill Greenwalt, industry consultant and a former staff member of the Senate Armed Services Committee.

The budget suggests the Pentagon would like to stop pouring money into legacy weapon systems and reallocate resources to next-generation technology, a shift that is long overdue, Greenwalt said. “What surprised me is that they didn't double down on current systems, buying more of the same, and instead the big increase is in RDT&E,” the account that pays for research, development, testing and engineering of new weapon systems.

The message this sends is that the Pentagon is feeling a real sense of urgency about the U.S. military falling behind rising powers like China and Russia in defense technology, said Greenwalt.

A flat procurement budget also implies that the Pentagon expects Congress will increase it anyhow. That is one reason the defense industry moneymen remain optimistic. As Trump’s policy agenda stalls and controversies mount, the Pentagon can still count on its strong allies on Capitol Hill.

Based on Wall Street’s downscaled expectations, the fiscal year 2018 budget is “on track,” said Roman Schweizer, defense industry analyst at Cowen Washington Research Group.

The poisonous atmosphere in Washington, however, could keep the Pentagon and the rest of the federal government in budgetary limbo for some time. And the Trump administration’s persistent push to cut health and retirement benefits, as well as the budgets of nondefense agencies to pay for tax cuts and boost military spending just keeps fueling the fire. “This seems to be the unspoken worry for investors and other GOP stakeholders in 2018,” said Schweizer.

Greenwalt predicts a rough ride ahead. “I think it's going to be difficult to get the increase for defense” that the president is seeking, let alone the much higher spending levels that congressional defense committee leaders have demanded. “Yes, the politics of this are going to be hard,” he said. “But the ramifications of not funding defense are going to be catastrophic for the military that has been undercapitalized for years.”

Trump’s budget is headed into a rough patch, especially in the U.S. Senate, defense analyst Byron Callan, of Capital Alpha Partners, warned investors. “The risk for defense is that D.C. gridlocks again and that DoD operates under a very lengthy or even full-year continuing resolution for fiscal year 2018 that cascades into FY19 planning.”

While there is little long-term insight to glean from a one-year budget that has been declared politically dead on arrival, the dramatic increase in RDT&E is hard to ignore. Callan sees this as the “most striking factor” of the defense budget request.

The increase is concentrated in the Air Force, with a 35 percent boost in RDT&E and the Army, with a 21 percent bump.

“The stepped-up RDT&E suggests a DoD commitment to funding next-generation concepts as its technology superiority is challenged,” Callan noted.

The choices made in the budget fall in line with Mattis’ broad guidance for equipping the military with more advanced technology over the next several years, although the details are still fuzzy. A shift of money from procurement to RDT&E would have “mixed implications” for defense contractors, Callan said, because research and development projects tend to be less profitable and carry a higher risk than mature production programs.

“The growth in advanced component development and prototyping funding is significant in our view and reverses trends in recent years where this account had been cut,” said Callan.

Another way to read this is that DoD will be moving away from traditional procurements and more toward “rapid prototyping” of new weapons, an approach that would challenge so-called programs of record.

Mattis’ desire to change how the Pentagon does business is another subtext to the budget proposal. He worries that the Pentagon spends “a lot of dollars and effort on things that may not meet the mission,” said Greenwalt. “We've been trying to modernize since the ‘80s” and results have been underwhelming, he said. The defense committees on Capitol Hill have hammered the Pentagon for making defense contracting too complex and unappealing to commercial companies that today generate most of the world’s technological innovation.

One of the winners in the defense budget, the space sector, appears to be on the cusp of disruption by lower-cost, more agile commercial firms. Congress for a long time has been pressuring the Air Force to shift to commercial space providers as companies pour billions of dollars into advanced technology. Maj. Gen. Roger W. Teague, director of space programs at the office of the Air Force Assistant Secretary for Acquisition, said the Pentagon “is looking very aggressively at the commercial industry” and is trying to offer incentives to newcomers to bid on military contracts.

Another early take on the 2018 budget: The Pentagon recognizes that it has gotten too complacent, and can no longer afford to be, and this budget might be a sign of coming change.

 

Sandra Erwin is a contributing writer. She can be reached at sandraerwin@gmail.com

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