Where Industry and Security Intersect
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The Effect of Imports of Gears and Gearing Products on the National Security
On October 17, 1991, the American Gear Manufacturers Association (AGMA) petitioned the Department of Commerce (DOC) to conduct an investigation under Section 232 of the Trade Expansion Act of 1962, as amended, to determine the effect of imports of gears and gearing products on the national security. Under the terms of Section 232, the President has authority to "adjust imports," should he concur with a DOC finding that a national security threat is present.
In its petition, the AGMA asserted that "the U.S. gear industry has filed (its) petition to illustrate the importance of our industry to the nation as a whole and promote action to ensure its continued viability." AGMA requested that "the entire range of remedies available under (Section 232) be examined and appropriate measures implemented," and further stated that "the U.S. gear industry seeks to avoid further deterioration by establishing a partnership with government to gain an equal footing with foreign competitors."
Section 232 (d) of the Act directs us to review the "domestic production needed for projected national defense requirements" and "the capacity of domestic industries to meet such requirements," among other factors. To meet these criteria, we focused our investigation on the Department of Defense's (DOD) statement that it requires an internationally competitive technically advanced gear production base able to participate in the development and production of state-of-the-art weapon systems.
BXA organized an interagency team of experts for this study effort, and conducted a comprehensive survey of all-identifiable gear producers and importers. Due to the indefinite lapse of the Defense Production Act, we conducted this survey without mandatory data collection authority. As a result, some of the most important gear producers and importer/end-users chose not to provide the requested information.
As basic components of most industrial machinery and equipment, construction and agricultural equipment, motor vehicles, ships, and aircraft of all types, gears are critical to the industrial base. From a military perspective, gears are critical to both the construction and performance of nearly all weapon systems, either as components of the many different machines required to produce a particular weapons system, or as components of the weapon systems themselves.
The gear industry is customarily divided into four sectors: motor vehicle, general industrial, aerospace, and marine. The latter two sectors represent only about 10 percent of gear industry shipments, but about 85 percent of defense gear shipments. Captive producers represent about 75 percent of gear industry shipments, but only about 25 percent of marine gear and 40 percent of aerospace gear shipments.
U.S. gear industry performance has declined markedly since the early 1980s. This decline can be explained based on a combination of factors including: the relative competitiveness of the U.S. gear industry; the decline of U.S. gear end-users (i.e. increased gear ‘imports’ embedded in foreign-built finished products); technological advances that have led to the decreasing use of gears in end-products; lagging investment in R&D and foreign government activities in support of their domestic gear industries. Recent exchange rate movements have, however, worked in a countervailing direction to increase the relative competitiveness of U.S. gear producers.
Gear producers responding to our industry survey are notably optimistic about their future competitiveness. Sixty-five percent of companies responding believe their competitive prospects will improve over the next five years, 18 percent believe competitiveness will "stay the same," and only an additional 18 percent believe that competitive prospects will decline. Further, about half of U.S. companies responding to our gear producers survey reported that their companies possessed technology equal to or better than their major foreign competitors.
Commerce gear industry experts believe that it is unlikely that alternative technologies will replace gears in the most critical defense applications any time in the foreseeable future. For the larger market, it is likely that worldwide gear consumption will continue modest growth, despite the development of alternative technologies, as new markets replace the old.
Gear research and development (R&D) is critical to maintaining both the technical superiority and cost-effectiveness of U.S. weapon systems. Joint DOD/industry funding of a very active aerospace gear RED program, for example, has allowed us to maintain technical leadership for gear systems used in helicopters and other aerospace systems. U.S. gear R&D has, however, trailed significantly behind the industry’s international competitors, and also behind the average for all U.S. manufacturers.
Our foreign trading partners also maintain a series of trade barriers that can potentially pose impediments to U.S. gear exports. Although most foreign governments claim that they offer no support targeted to their domestic gear industries, other broad-based industry supports and/or support to major gear-consuming industries may be detrimental to the viability of the U.S. gear industry.
Overall gear industry shipments followed a downward trend over the 1988 to 1991 period. In contrast, the marine sector showed strong growth in 1991 over very low 1988 levels, and the aerospace sector showed only a modest decline.
Industry-wide imports accounted for a growing percentage of new gear supply (domestic shipments plus imports), rising from 13.5 percent to 18.0 percent over the four year period. In the aerospace and marine sectors, however, imports were flat over this period.
Defense shipment data were reported by companies responding to our producer and importer/end-user surveys. Due to the intermediate nature of gear products – i.e., they are incorporated into finished goods, it is likely that many producers are unaware of the ultimate end-use of their products. It is, therefore, probable that the reported defense share of gear shipments and imports is understated.
Reported defense shipments represented a substantial majority of gear shipments by the aerospace and marine gear sectors, but only around two percent of shipments by the automotive and industrial sectors. The reported import share of defense new supply was less than five percent, and stable over the survey period.
Although the gear industry has shown a steady decline in production worker employment, there has been a continuous increase in total output and productivity (measured as output per employee hour) as reported for the more aggregate Standard Industrial Classification code 35 (machinery, except electrical).
The Department of Labor cautions that continued declining employment in the gear industry will accelerate the loss of skills. While the supply of unskilled workers available to the gear industry is adequate to meet current and anticipated needs, the availability of skilled workers in a national security emergency is problematic.
The United States government has several programs and regulations in place that affect the gear industry. DOD, in particular, operates several grant programs through which it has provided significant support for gear industry R&D required to support the DOD's national security objectives.
A variety of other government programs available to assist the gear industry's revitalization efforts include: DOC/International Trade Administration export promotion, DOC/Economic Development Administration efforts to assist communities in adjusting to decreased defense procurements, and Small Business Administration business loans, among others.
The majority of gear producers responding to our survey stated that their competitiveness had been affected by the need to adjust their firm's business practices in response to U.S. government policies. Company concerns focused on procurement-specific problems, as well as on broader issues.
When producers were asked what adjustments should be made in U.S. government policies, the largest number of companies suggested the reinstatement of tax incentives for capital investment. A large number of companies also asked for the institution of "Buy American" preferences on government gear procurements, and for tougher enforcement of the unfair trade laws.
Due to recent substantial changes in the national security challenges facing the United States, it was not possible to develop a quantitative estimate of national security requirements for gears and gearing products to be incorporated into this investigation.
In lieu of such requirements, DOD was able to inform us that it anticipates that gear requirements will be substantially decreased in the near future as procurement is cut back by as much as half. Defense officials emphasized that the most likely contingencies would be for 'come as you are' regional conflicts such as Desert Storm, which would require that DOD be able to rely on a 'warm' industrial base prepared to meet unpredictable increases in short-term defense requirements.
Surge production capacity for a given year is defined as the maximum realistic level of production that a manufacturing establishment can achieve during a twelve-month period. In the more defense-intensive aerospace and marine sectors, estimated surge production capacity increased only 54 percent and 53 percent respectively during the twelve-month period. In the less defense-intensive gear sectors, industrial and automotive gear producing establishments reported an ability to increase capacity 135 percent and 132 percent respectively over twelve months.
Gear products and processes are, however, generally not fungible between the various gear sectors. This is particularly relevant for the defense-intensive marine and aerospace sectors which require greater precision and a great commitment of capital, labor and time than the industrial and automotive sectors.
Total reported lead times (from initial receipt of a customer's gear order to delivery) ranged from just seven weeks to more than three years. Generally, the higher the precision, the longer the lead time. The average lead time for defense gear orders was nearly 28 weeks, with marine gears having the longest lead times.
Companies responding to our producer survey were asked to identify and rank in order the top five bottlenecks affecting their ability to ramp-up to production capacity. Heat treatment was the bottleneck mentioned most often, followed closely by gear grinding and gear blank production. In a period of long-term declining demand for defense gears, it becomes increasingly difficult to justify maintaining excess capacity able to meet highly-demanding, and more costly defense specifications.
For the automotive and industrial gear sectors, defense gear usage is small, and it is likely that ample gear capacity would be available to meet needs during a national security emergency. In the more defense-intensive aerospace and marine gear sectors, however, it is possible that sufficient capacity may not be available to meet national security gear requirements.
However, it is unlikely that imports have significantly impacted the gear industry’s ability to meet national security gear requirements. Imports as a percentage of new supply have been stable over the 1988-91 period in the aerospace gear sector, and have actually declined over this period in the marina gear sector. Imports as a share of defense new supply for these sectors have been even lower and have also been stable over this period.
The decline of the commercial gear sector, combined with the prospect of significant decreases in defense procurement, increases the economic pressure on U.S. gear producers. If these trends continue, the United States may become dependent on foreign countries for defense-critical gears in some industry sectors. There are both benefits and costs to relying on foreign suppliers for gears and other defense-critical components.
Allegations were made by U.S. gear producers that U.S. bidders had been disqualified from European gear procurements based upon their nationality. Details of these allegations have been provided to the appropriate DOD official who intends to seek resolution from his European counterparts.
Several independent gear producers further alleged that particular U.S. prime contractors have informed them that they will stop sourcing gears from independent U.S. producers by the end of 1994. U.S. primes denied that they intend to change their gear supplier mix, but emphasized that they must be certain of the long-term viability of gear suppliers.
U.S. primes further noted that some foreign gear suppliers have both sufficient financial resources to provide the necessary financing (i.e. to become risk/revenue sharing partners), and the production capability to reliably produce other low-compression aircraft engine components. Primes caution that it would take an average of two years to qualify new gear sources at Federal Aviation Administration and DOD standards if forced to abandon joint venture relationships with offshore producers.
We conclude that the substantial cost of system development leaves U.S. prime contractors with little alternative to seeking offshore risk/revenue sharing partners. In attempting to alleviate the national security concerns raised by the declining gear production base, we should ensure that we do not weaken prime contractors and thereby impose a substantial national security cost. However, it is at the same time important for the U.S. To maintain a competitive and technologically viable domestic gear production base.
The Department of Commerce does not find that gears and gearing products are being imported into the United States in such quantities or under such circumstances as to threaten to impair the national security.
The Department reached this finding based on: 1) anticipated substantial decreases in defense procurements which will likely lead to significantly decreased defense gear requirements; 2) the low and relatively stable level of imports in the defense-intensive aerospace and marine gear markets; 3) the U.S. Industry’s continuing technological competitiveness and its optimism about its future competitiveness; and 4) the Department of Defense's proven record and continuing commitment to address sector-specific national security gear supply concerns when they may occur.
In light of the negative finding above, we do not include any recommendations to "adjust imports." We recommend the following, however, to address ancillary issues that arose during this investigation:
In fulfillment of President Bush’s April 1990 Policy on Offsets in Military Exports, we recommend that consultations be initiated with foreign governments to examine the extent to which offset and/or co-production commitments have led U.S. prime contractors to source gear products from foreign suppliers to the extent of raising national security concerns about the future viability of U.S. defense gear suppliers.
We encourage the Department of Defense to carefully consider the national security issues raised within this report, and recommend that it continues its significant effort to support defense-critical gear industry research.
We recommend that the Department of Defense continue to encourage its contractors and their independent gear suppliers to develop a cooperative sustainable partnership. This is particularly significant in light of assertions that important U.S. prime contractors intend to cease purchasing gears from independent U.S. gear producers by the end of 1994. These assertions could not conclusively be either confirmed or denied during the Section 232 investigation.
We urge the DOD-led Defense Conversion Commission to study the impact of declining military budgets and major weapons system terminations on domestic gear producers and other key subcontractor industries. In addition, the Commission should examine the potential to convert excess defense-dedicated production lines and employees to commercial products.
We recommend that the DOC’s Economic Development Administration continue its contacts with the U.S. gear industry to provide technical assistance to the industry in its defense conversion efforts.
We reiterate the recommendation in our January, 1991 National Security Assessment of the U.S. Gear Industry that the industry take the initiative to consolidate into larger more technologically efficient firms that can both afford and justify investment in the latest technologies.
We further reiterate our recommendation that U.S. government and AGMA statistical representatives continue to work to rectify current data shortcomings and t explore the need for better government monitoring of the U.S. gear industry’s performance.