Last Recession’s Demon Could Be This One’s Angel

Tuesday, Feb. 10, 2009 | The last time recession walloped San Diego, blame could be squarely placed on the defense industry. Huge aerospace companies, which dominated the local economy, shut down plants and shed thousands of jobs in the early 1990s as a result of large-scale military base closings precipitated by the end of the cold war.

Now, as the local economy struggles through another, and possibly far more severe recession, the defense industry is looking like one of the very few bright spots. And going forward, economists and industry experts see the sector as a stabilizing force, and perhaps a stimulator, as the downturn continues.

“It’s not the problem this time around — and it may even sustain the economy,” said Kelly Cunningham, economist for the National University System Institute for Policy Research.

The region lost more than 18,000 jobs from December 2007 to December 2008 — the retail and construction sectors lost more than 8,000 jobs and 5,000 jobs, respectively. Biotech has also been hammered, with layoff announcements seemingly a weekly occurrence in the industry. Defense contractors, although not counted as their own category in employment statistics, have been noticeably missing in this flood of dire reports.

Defense firms have been helped tremendously by the fact that their revenue comes from the federal government, which, unlike private companies, and even state and local governments, has not cut spending in the face of the economic crisis. Combined with the wars in Iraq and Afghanistan, they are all reasons why, industry watchers say, that defense contractors will have stable income for at least the next couple years.

A few say that the eventual fallout of the $838 billion stimulus package just passed by Congress could easily change the landscape for defense companies. And President Barack Obama has pledged to increase oversight of federal contractors.

To be sure, the industry does not have the same impact on the overall economy as it once did — defense spending accounts for about 10 percent of the gross regional product, about half of what it accounted for in the 1980s, Cunningham said. And it doesn’t look the same either. The typical San Diego defense contractor is no longer a massive firm that builds cruise missiles or airplane parts; it is a small or medium-sized high tech company.

The region remains home base to large defense contractors like SAIC and General Atomics, and behemoths like General Dynamics and Northrop Grumman still have large operations here. But the face of San Diego defense contracting is the hundreds of niche companies specializing in software development, telecommunications systems, remote sensing or any number of other high-tech applications. Helping the region immensely is its hosting of Space and Naval Warfare Systems Command, or SPAWAR, the Navy’s research and development center.

“Our companies are pretty broadly diversified in areas that are going to remain important, and become more important,” said Gerry Nifontoff, a chief systems engineer for SAIC, and president of the San Diego chapter of the National Defense Industrial Association.

“What the future holds is you don’t have hardware (missile systems, new airplanes and new ships), you have the ability to operate in the information space — cyber attacks, cyber defense and psychological operations — the soft kill rather than the hard kill. San Diego is well positioned for the soft kill.”

Marney Cox, economist for the San Diego Association of Governments, estimates that $6 to $8 billion of the roughly $15.5 billion in U.S. Department of Defense funds that flow into San Diego go to high tech companies. And the research and development work they do will very likely stay in demand. They say this despite the perception that a Democrat in the White House is bad news for defense contractors.

President Obama has vowed to pull out the vast majority of troops in Iraq, but he has also promised to beef up the force in Afghanistan. And regardless of how the Obama Administration deploys U.S. troops, communications and monitoring technologies will be important, Cox said.

“And that is where San Diego’s economy can contribute the most,” he said.

There, however, are potential pitfalls for the local industry. One might be the massive infrastructure spending and tax cuts promised in the stimulus bill. At some point, Obama and lawmakers will have to grapple with a likely trillion dollar-plus deficit, and defense spending could become a target.

“Currently, we have a stable funding environment,” said Dwayne Junker, the chief operating officer of San Diego-based Epsilon Systems Solutions, Inc., which does a variety of things for the Defense Department, from designing communications systems to manufacturing “ruggedized” flat panel displays for ships, submarines, tanks and aircraft. However, Junker describes his optimism as “guarded” because of the potential impact of the stimulus bill.

He said it is not a question of if the stimulus bill will have a negative effect on Defense Department spending, but to what extent. Procurements for new technology might be vulnerable as timelines for implementing new systems are stretched out due to the budget deficit, he said.

“To what degree that will occur is an absolute crap shoot,” Junker added. “We’ve never dealt with an issue like this stimulus plan before.”

Nifontoff said it is unlikely that any significant change to defense spending will happen before the 2011 budget because appropriations bills for 2010 are already being written by members of Congress who would be loathe to reduce any spending at this point.

But changes in Congress, as well as clear signals from the Obama administration that there will be more scrutiny on government contracting, could have a shorter-term impact on San Diego defense contractors, said Doug Farry, a managing director in the San Diego office of Washington, D.C. law firm McKenna, Long & Aldridge.

For one thing, Farry said, the region lost its most powerful advocate with the departure of Duncan Hunter, R-Alpine, as chairman of the House Armed Services Committee. Hunter’s son, Duncan D. Hunter Jr., won his seat in November and will serve on the Armed Services Committee, but he will not have near the power that his father did.

Farry also said that the Obama Administration has already sent out three executive orders having to do with union labor rules for government contractors that were waived under the Bush Administration. These rules, which among other things impact how contractors can hire and fire their workers, could significantly increase compliance costs, he said.

“The other thing that is of some significance to this region is that both the House and Senate have aggressively ramped up investigation and oversight capability of defense contracts,” Farry said. “The perception is that during the Bush era, defense contractors got a lot of sweetheart deals, and members of Congress are determined to expose any fraud, waste and abuse.”

Please contact David Washburn directly at david.washburn@voiceofsandiego.org with your thoughts, ideas, personal stories or tips. Or set the tone of the debate with a letter to the editor.