Section IX

DEFENSE RESOURCES

The QDR included consideration of the fiscal environment in developing a program to meet the requirements of the defense strategy. Absent a marked deterioration in world events, the nation is unlikely to support significantly greater resources dedicated to national defense than it does now - about $250 billion in constant 1997 dollars per year. Indeed, any slowing of progress in reaching deficit reduction targets could generate pressure to lower DoD spending. At the same time, DoD already faces tensions among the resource priorities within its own budget and program.

The most immediate symptom of these tensions has been the chronic migration of funds the Department had planned for procurement to operations and support (O&S) activities. More fundamentally, the financial plans underlying the Department's commitment to maintain high readiness, protect force structure, and invest in modern equipment have become increasingly vulnerable to a range of potential disruptions, some quite likely and predictable, others more uncertain. Consequently, an important task of the QDR was to determine, on the basis of the chosen strategy, where to make program adjustments that would improve the Department's financial posture. The difficulty of making these determinations mirrored the fundamental challenge of the strategy: how to strike the right balance between meeting urgent obligations in the present and investing in imperative modernization for the future.

THE INVESTMENT CHALLENGE

Fulfilling a strategy of shaping the international security environment, responding to the full spectrum of crises and aggression, and preparing now for the future require substantial and ready forces, together with a focused program of investments to improve the equipment those forces will employ. Although existing plans continue to project significantly increased funding for modernization, the Department's record of having to pay operating expenses out of funding planned for investment threatens the viability of those plans. Therefore a focus of the QDR was to build a solid financial foundation for a modernization program that could reliably support the future warfighting capabilities called for by Joint Vision 2010. The key to that foundation is to halt the chronic disruption to modernization plans by properly projecting and funding the Department's operating and support activities.

The $60 Billion Goal. To modernize the force, the Department established a goal of increasing procurement funding to roughly $60 billion by FY 2001. The Chairman of the Joint Chiefs of Staff affirmed that goal during preparation and presentation to Congress of the last two defense budgets. Although we have made some reductions in the modernization program as a result of the QDR, $60 billion remains the rough level of procurement funding the Department believes is necessary to modernize even the slightly smaller force that will result from the QDR. On the path to that goal, the Department has established somewhat lower intermediate targets of $49 billion in FY 1999 and $54 billion in FY 2000. Continuing efforts to reduce the costs of the defense infrastructure will be needed to achieve those targets.

The Modernization Imperative. In the years immediately following the end of the Cold War, the Department's reductions in spending came disproportionately from reductions in procurement spending, a decision that reflected a prudent, calculated risk initiated by the Administration of President Bush and continued by this Administration. This approach was possible because large quantities of modern equipment had been purchased during the 1980s and force reductions had permitted the retirement of older ships, aircraft, and armored vehicles in the early 1990s. That drawdown is now over, the dividend from procurement reductions has been spent, the procurement holiday must end, and investment in modernization needs to rebound. Otherwise, the technological superiority of our forces - and our ability to sustain their equipment stocks - will erode over time.

However, each new defense program since completion of the Bottom-Up Review in 1993 has had to postpone the previous year's plan to begin increasing procurement spending. As a result, with each successive budget, the trough in the Department's procurement plans has shifted one year into the future and the cumulative amount of procurement planned in each program has declined. For example, whereas the FYDP associated with the FY 1995 budget developed after the Bottom-Up Review had planned an increase to procurement in FY 1998 to $54 billion, the budget submitted in February of this year requests procurement funding of $42.6 billion. In addition, in the budgets for FY 1996-1998, there was a cumulative loss of $18 billion in procurement funding relative to the BUR plan.

These postponements have been a reflection generally of the high priority the Department attaches to current spending on readiness. But in addition, they have occurred because our planning has not managed financial risk in a way that reflected the importance we also attach to investing in the future. As the most discretionary area of the budget within an established force and operating posture, modernization has borne a disproportionate share of the disruptions and alterations that occur in the preparation and execution of budgets and programs. Unprotected from this pattern of migration, procurement plans most likely would continue the pattern of erosion they have experienced in recent years, and the planned increase from $42.6 billion to roughly $60 billion would fail to materialize.

ASSESSING RESOURCE CHALLENGES

Consequently, a principal resource management objective of the QDR has been understanding financial risk in the Department's program plans and devising approaches to manage that risk. The first step was a detailed analysis of the potential sources of instability that are built into the current FYDP, and the implications of that instability for funding requirements in the years beyond 2003. This analysis served to frame the fiscal context for making decisions in the QDR and will improve the prospects for full execution of the directions resulting from it.

The assessment focused on three sources of disruption to the Department's program plans:

Migration. The primary source of instability in the Department's current plans is the migration to other activities of funding planned for procurement. This chronic erosion of procurement funding has three general sources.

The magnitude of financial risk associated with these sources of migration varies. Given the international security environment and strategy on which the QDR was based, the potential for at least some amount of unprogrammed costs materializing from, for example, contingency operations is high. The advent of other unprogrammed expenses, as from savings initiatives not fully realized, is much more uncertain and depends heavily on the Department's progress in more efficiently operating the defense infrastructure. On balance, the QDR proceeded from the assumption that, by the end of the current six-year plan, as much as $10-$12 billion per year of funding would be at risk to migration arising from unplanned bills, unrealized savings, and new program demands. Under those circumstances, procurement funding would erode from the planned level of more than $60 billion in the FY 2001 to 2003 period, to a range of $45 billion to $50 billion, but no higher. Against the strategy and modernization priorities resulting from the QDR, a procurement program of no more than $50 billion per year is clearly inadequate. Deterioration and obsolescence in equipment would erode long-term force structure and compromise the technological superiority of future forces. The concepts called for in Joint Vision 2010 could not be realized.

To address the migration problem, the Department will redirect resources, building to about $6-7 billion annually by the end of the FYDP, from the savings made available by trimming forces (see Section V), streamlining the infrastructure (see Section VIII), and adjusting modernization plans (see Section VII). Using these resources to program more accurately for the costs of operating the defense establishment and to hedge against the loss of the savings we expect to accrue from cost-reduction initiatives will go a long way toward breaking the pattern of erosion in our procurement plans. Although the savings identified in the QDR represent real progress in mitigating the possibility of future funding migration and will therefore substantially enhance stability of the defense program, further savings are needed to secure fully the planned modernization program.

A number of other steps can help address this challenge. Additional rounds of base realignment and closure would generate steady-state savings of up to $3 billion per year. Deeper reductions to the defense infrastructure through more fundamental reform of these activities - a chief object of the Task Force on Defense Reform - could also generate needed investment funds in future years.

Without addressing the migration problem aggressively, there will be little margin for error in sustaining modernization plans in the face of unexpected demands for operating expenses or other new funding requirements.

Long-Term Challenges. The first long-term challenge to the defense program is represented by potential shortfalls in minor procurement funding. A growing shortage of smaller items of equipment may in the future present a demand for unplanned expenses that are essential to maintaining the material condition and readiness of U.S. forces. Items of equipment like generators, field kitchens, and incremental modifications to electronic equipment - things essential to field operations - are being funded in current plans at levels well below their historical average. These plans may reflect a change in the traditional composition of the Services' procurement requirements. But they may also reflect a shortcoming in the Department's planning for these requirements, introducing a risk to procurement plans somewhat akin to that of unforeseen requirements for depot maintenance and real property maintenance. These additional demands may require future growth in investment funding of some $2-3 billion per year - further strengthening the Department's motivation to generate savings in infrastructure costs and to implement acquisition reforms to minimize the cost of the equipment needed to sustain the force.

A second long-term resource challenge concerns projections of funding requirements for modernization beyond the end of the current program in 2003. As successive FYDPs reduced the amount of procurement programmed in the six-year planning period, some of these reductions have accumulated into long-term projections, creating a so-called "bow wave" of demand for procurement funding in the middle of the next decade.

This bow wave is a source of risk to the long-term affordability of the Department's modernization plans. Since the Defense budget began declining in the late 1980s, the Department has paid closer attention to this risk. Current projections indicate that the accumulation of investment funding requirements in the years beyond the FYDP could grow by several billion dollars to support projected modernization programs. Though quite modest by historical standards and affecting selected programs, this bow wave would tend to disrupt planned modernization programs unless additional investment resources are made available in future years. Some of the rationalization of out-year modernization resulting from the QDR, especially in aviation, will have the effect of flattening the bow wave - improving future affordability and therefore the stability of the overall defense program. Realization of additional infrastructure savings through fundamental reforms and base realignments and closures will also help sustain the long-term modernization of the Department's forces.

Technical Risk and Uncertainty. Complex, technologically advanced programs all bear some risk of costing more than planned. When unforeseeable growth in costs occurs, offsets from other programs must be found, which in turn disrupts the overall modernization program. Our programming process must provide sufficient flexibility in the form of program reserves to address this risk. As a result of the QDR analysis, each military department plans to establish a prudent funding reserve in its out-year plans to offset these types of cost increases and significantly reduce one of the destabilizing factors affecting our modernization programs. Additionally, the Department will select several "pilot programs" that will carry similar reserves in the budget as a means of mitigating significant cost or schedule impacts that arise in the year of execution.

A NEW BALANCE OF RESOURCES

The program adjustments resulting from the QDR will strike a better balance in the DoD's program and financial plans between meeting the urgent obligations of the present and investing in imperative modernization for the future. Consistent with the strategy and force posture, these adjustments will provide for a more stable and sustainable modernization program into the next century. However, even after taking these steps to protect procurement plans from disruption, some potential for migration will remain. The extent to which a more stable budget and program provide predictability, which in turn helps control acquisition costs, should mitigate some of that remaining financial risk. That some potential for funding migration will remain in the defense program after implementing the QDR only serves to underscore the importance of the Department's continuing efforts to achieve fundamental reform of its infrastructure and revolutionary changes in its business practices.

In terms of its impact on resources, the achievements of the QDR will not be immediately evident in the numbers. The total funding planned for procurement will be somewhat reduced from the out-year plans reflected in the FY 1998 President's budget. However, new budget projections that result from the QDR should be both more sustainable and less vulnerable to continued migration. The true test of any financial plan is not only in its numbers, but especially in the stability and reliability of its forecasts and in their suitability to the strategy that they serve. By this measure, the QDR will prove to have made a signal contribution to the Department's stewardship of the resources the nation commits to national defense. While upholding the capability and readiness of the force, the QDR will have launched a plan to modernize for the future whose foundation is more reliable and secure.

NEXT STEPS

The QDR has made a significant effort to understand the prospective programmatic and budgetary effects of the options it considered and resulting decisions, and this report faithfully reflects the results of that effort. Now that the QDR is complete, the Department will proceed to implement the blueprint of the QDR's broad direction by engineering its details into the budget for FY 1999 and program plans through FY 2003. The full implications of the QDR on programs and budgets will reach definitive expression in the submission of a new budget and program in February 1998.

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