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November 2,1973 P ro b lem s The events of recent weeks have shown that we live in a very uncer tain world. An international crisis has erupted in the Middle East, as sociated with the heaviest desert fighting since El Alamein, and the human and financial costs for all participants have mounted daily. These developments underline the fact that U.S. defense spending is now rising again from its recent low — and may well continue rising. The increase is shown most dramatically in new budget authority, which sig nals the strength of future budget spending. Budget authority includes amounts which, under Congres sional authorization, enable the Pentagon to enter into obligations requiring future outlays of money. From a low of $75.2 billion in fiscal 1971, budget authority increased to $81.7 billion in fiscal 1973, and last January's budget shows twice as fast an increase, to $87.3 billion for the current fiscal year. (The total would be expanded by the recent $2 .2 billion supplemental request related to the Middle East crisis; on the other hand, it should be noted that the total figure is an approximation, since authorized funds sometimes are not actually spent.) This sharp budget increase is taking place de spite a continued cut in military manpower, down 37 percent from the fiscal 1968 peak. How much is enough? How much defense capability do we have? In terms of numbers, we have roughly the same in strategic and http://Traser.stlouisfed.org/ Federal Reserve Bank of St. Louis tactical air strength, and somewhat less in naval and ground forces, than we had in fiscal 1964—the postKorea, pre-Vietnam high. Forexample, we now have 13 instead of 15 attack carriers, and 16 instead of 191/3 army divisions. However, in terms of firepower and other combat characteristics, we now have considerably more than a dec ade ago— for example, through the introduction of multiple warheads for the strategic-missile force. How much do we need? The ques tion is unanswerable, in view of all the military, political and economic intangibles involved in the world power equation. At present, military purchases account for only about 6 1/2 percent of CNP, the smallest share of the past two decades. Some observers claim that not nearly enough resources are allocated to defense, but others argue that the present allocation is far more than necessary. Military planners, concerned with the capabilities of all possible adver saries, argue for a considerable beefing-up of the armed services. Indeed, military studies early in the 1960s estimated that 52 divisions— in contrast to our present 16— con ceivably would be required to cope with all the possible trouble spots in the world. On the other hand, critics contend that savings could be made in a number of areas— by reducing budgeted spending in Southeast Asia, by improving military man power usage, and by eliminating or postponing the procurement of new (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. strategic weapons. With savings from these areas, spending authority could be reduced from $87 billion to $73 billion in fiscal 1974 alone, according to a recent study au thored by the Project on Budget Priorities, a group of former De fense Department officials. Although few can agree on how much is enough, all observers realize that the Pentagon has ab sorbed vast amounts of resources despite its declining share of GNP. The U.S. has spent over $1 trillion on defense since World War II, and the amount spent just within the past decade ($680 billion) just about equals the $689 billion collected in Federal personal-income taxes over that period. The realization of the large sums involved has led to con tinued demands for efficiency in manpower usage and weapons pro curement. M anpower costs Manpower has become an increas ingly important segment of the defense budget. Dollar spending for military pay and allowances has doubled over the past decade, and the manpower share of the defense budget has jumped from 41 to 56 percent. The acceleration in military pay has been largely due to the need to attract enough volunteers to permit the elimination of the draft, effective last July 1. This is the main factor behind the rise in total defense spending over the past several years. The policy of sharp pay raises has transformed a military cost long Digitized for F R A S E R . hidden from view into an explicit dollar addition to the defense bud get. Formerly, through the vehicle of the draft, the government was able to pay young men far less than prevailing market rates for their services. A certain segment of soci ety— males aged 19 to 26— was taxed in kind by being paid sub standard wages for the two-year draft period. Now, with the shift to all-volunteer armed forces, the gov ernment pays prevailing market rates, permitting this special tax to be redistributed among the entire taxpaying population. The increase in spending for military personnel, in other words, is a nec essary consequence of the political decision to end the draft. The higher pay and other costs associated with this shift will total $3.1 billion in fis cal 1974 and substantially more in later years. The most striking im pact, however, should be seen in the soaring costs of the military re tirement system, which is affected by both rising pay scales and the ris ing number of retirees. Between 1950 and 1970, retirement costs went from $0.2 billion to $2.8 bil lion, but in 1990, these costs may total $14.4 billion— and may rise to $24.7 billion in the year 2000— ac cording to actuarial data prepared by the Senate Armed Services Com mittee. Certain personnel practices have also added inordinately to man power costs. One problem is the unbalanced "teeth-to-tail" ratio, with only 15 percent of all personnel in combat forces, and the rest standing in support. Another problem is "grade creep." There are more field grade and flag officers to command 2.2 million men today than there were to command 12.1 million men in 1945; also, there are more sergeants than there are re cruits today, compared with a 1945 ratio of seven recruits per sergeant. A development of this type should be expected as the services shift to ward an all-volunteer force. Still, if the grade structure existing at the end of World War II were in effect today, payroll costs at today's pay scales would be $2.7 billion less than they actually are. Procurem ent costs Defense Department officials, in one administration after another, have encountered serious problems in controlling the costs of military procurement. Costs are especially difficult to estimate in any case, partly because of inflation, but mostly because entirely new tech nologies are required in the produc tion of many new weapons. During the crash programs of the 1950s, weapons cost about three times as much as initially expected, while in the less urgent days of the 1960s, final costs averaged about two times estimated costs. Moreover, between 1957 and 1970,81 major projects with a $12-billion pricetag were cancelled altogether. Three years ago, the then-Deputy Secretary of Defense, David Pack ard, declared that defense procure ment was in a "real mess," and he thereupon moved vigorously to im- Digitized for F R A S E R prove the efficiency of the weaponsacquisition process. Several of his reforms deserve special mention. First is the "fly before you buy" approach, which requires the serv ices to know as much as they can about the product before they buy it in substantial quantities. Second is the upgrading of management ex pertise in the services, by improving the quality of program managers and increasing their authority. Third is the increased control of "gold plating", by reducing the tendency to design more sophisticated wea pons than are required for the tasks assigned. Yet no matter what is done in the way of controlling manpower ex penses and improving the weaponsacquisition process, defense spend ing appears to be due for a consid erable expansion in the years ahead. According to the annual Brookings Institution budget analysis, simply maintaining current defense policies would require a 15 percent increase in budget requests between now and 1980, to a figure of $97 billion — or $114 billion after allowing for price increases. (If associated pro grams were included— such as wardebt related interest, veterans pen sions, and the operations of the space and atomic-energy programs — another 35 to 40 percent could be added to the final bill.) If defense requests should develop along this line, Congress will continue to be under pressure to reform its budget procedures and sort out its spending priorities, to assure that the Federal budget does not again become an engine of inflation. W illiam Burke uojSuiqscM • jiea ^ h • uoSteJO • ep^AaN • OM«PI • e|UJOjije3 • e u o zu y • e>|se|v J 0 3F » g | p a » p a ) j[ BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (D ollar amounts In m illions) Selected Assets and Liabilities Large Commercial Banks Loans adjusted and in vestments* Loans adjusted— total* Securities loans Com m ercial and industrial Real estate Consum er instalment U.S. Treasury securities Other securities Deposits (less cash items)— total* Demand deposits adjusted U.S. Government deposits Tim e deposits— total* Savings Other time I.P.C. State and political subdivisions (Large negotiable CD 's) Weekly Averages of Daily Figures Am ount Outstanding 10/17/73 Change from 10/10/73 74,490 57,490 1,019 19,953 17,663 8,783 5,250 11,750 73,048 21,818 593 49,384 17,508 22,830 5,862 11,351 — 3,200 — 2,745 — 2,310 — 318 + 82 + 6 — 111 — 344 — 655 — 679 + 143 + 4 + 20 — 145 + 13 — 152 W eek ended 10/17/73 Change from year ago D ollar Percent + 9 ,7 4 9 + 9 ,7 0 5 — 198 + 2 ,7 2 3 + 3 ,1 1 2 + 1 ,3 6 8 — 686 + 730 + 8 ,9 5 2 + 1 ,5 0 6 — 70 + 7 ,4 5 0 — 833 + 6 ,2 0 9 + 922 + 5 ,3 7 8 + + — + + + — + + + — + — + + + 15.06 20.31 16.27 15.80 21.39 18.45 11.56 6.62 13.97 7.41 10.56 17.77 4.54 37.36 18.66 90.04 W eek ended 10/10/73 Com parable year-ago period — 9 71 — 80 43 113 — 70 — 70 66 — 136 — 173 +278 — 389 — 230 +520 +133 Member Bank Reserve Position Excess reserves Borrowings Net free ( + ) / Net borrowed (— ) Federal Funds— Seven Large Banks Interbank Federal funds transactions Net purchases ( : ) / Net sales (— ) Transactions: U.S. securities dealers Net loans ( : ) / Net borrowings (— ) “Includes items not shown separately. Information on this and other publications can be obtained by calling or writing the Diaitized for F R A A ER * n*strative Services Department. Federal Reserve Bank of San Francisco, P.O. Box 7702, http://fraser.stlouS ^ FJfg/cisco' CalMomia n ° n* <415> 397-1137. Federal Reserve Bank of St. Louis
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