Today, the President will release a FY 2020 Pentagon budget that proposes to increase in Pentagon budget authority by more than $30B via a gimmick: increase the proportion of the request attributed to Overseas Contingency Operations even as the US plans to do less overseas. While that particular tactic seems DOA on the Hill, the President's Pentagon budget proposal is still the best predictor of the shape of the FY 2020 and 2021 Pentagon budgets. We will publish subsequent notes as data is released in the next day or so (spoiler alert: we expect a two year deal late in the year, slightly lower than the President's request and after a lot more drama).
Although full data from the imminent release of the FY 2020 budget request will not be available for a day or so, we already know enough now to highlight the area of the $750B behemoth that has shown the greatest growth over the past three years and is set to grow even faster in 2020: Research, Development, Testing and Evaluation (RDT&E).
The Treasury Department's January statement, out a month late due to the government shutdown, shows that Defense budget authority increases that were put into the pipeline in 2017 are finally turning into outlays, the true indicator of defense company revenues.
- Pentagon investment (procurement + RDT&E) outlays for the first third of FY 2019 were $66.8B, up $7.3B or +12.3% compared to the same period last year.
- Within the 2019 investment total, R&D outlays are up an astonishing 21.7% over the same period in 2018 and, at 40% of the total, are a growing proportion of an ever larger investment budget.
- R&D Growth to accelerate. In advance of the official budget release, Acting SecDef Shanahan has confirmed that the Pentagon will ask for $104B in budget authority in FY 2020, an increase of ~$5B (~5%) over the record $99B appropriated in FY 2019 and fully $11B (~12%) more than planned for FY 2020. We estimate that $104B will be ~44% of the total investment budget authority for FY 2020.
<
>
<
>
Takeaways:
- Increased R&D spending reflects consensus concern that the US is losing its technological advantage in Great Power competition. While the SecDef former USMC General Mattis is gone, his strategy to reorient the Department on competition with Russia and China remains in place. The increase in outlays particularly within the Air Force reflects the ramping up of the Long Range Strike Bomber development (NOC), hypersonics (LMT) and classified programs.
- R&D contracts are usually "cost plus" contracts with lower margins compared to procurement contracts. While it is essential for defense companies to participate in R&D contracts in order to be competitive on procurement contracts, they are relatively small potatoes to the real prize, producing the developed capability.
- The recent and ongoing increase in R&D outlays is unlikely to lead to an equivalent increase in procurement outlays two to three years hence. While development is a necessary precursor to subsequent procurement, the relationship is not one to one. The timing of this particular surge in RDT&E for actual delivery of capabilities is relatively poor in the face of mounting fiscal and political pressures on the defense budget. While RDT&E has seen a ~17% CAGR over the last three years, we are unlikely to see anything close to that in procurement spending in the coming FYDP.
