Is there really $125B in Pentagon Waste?

Imagine you're the Deputy Secretary of Defense, and in walks a group of consultants who tell you that you can save $125 billion over five years if you act on their recommendations. They say you need a clear science and technology strategy, to establish rigorous management processes, and so forth. They say savings will start immediately. You flip through their PowerPoint brief stacked with charts and buzz words like optimize, modernize, and agile enterprise. You get weary when a slide shows, in pictographs, how you can re-program the efficiency savings to 50 brigades, 10 carrier strike groups, or 83 F-35 fighter wings over the same five year time frame. Slow down, you think. You don't want Congress getting a hold of the idea that there is $125 billion in waste can disappear overnight because you know there are no easy answers of the kind peddled by consultants.

That is, unless you're Deputy Secretary of Defense Bob Work. As Craig Whitlock and Bob Woodward reported in the Washington Post, Mr. Work did in fact get worried when he saw the chart depicting the savings. He got worried, however, that the DoD could easily save those billions and that Congress would want it back! The journalists wrote that the report by private consultants unambiguously laid out "a clear path" to $125 billion over five years. Former chairman of the Defense Business Board Robert L. Stein called the study's data "indisputable" because it came from the Pentagon itself. Because the DoD feared that Congress would "use the findings as an excuse to slash the defense budget," officials decided to suppress the "internal study that exposed $125 billion in administrative waste."

Frank Kendall, Undersecretary of Defense for Acquisition, Technology, and Logistics (AT&L), fired back that the consultants' study was "shallow" and failed to grasp basic obstacles to restructuring the public sector. The Washington Post journalists shrugged at the response and suggested that Pentagon officials were just trying to "wait things out" rather than tackle the hard issues at hand. It makes one wonder whether the journalists actually read the report. Perhaps a brief foray into the 125 billion-dollar report will give the reader a feel for the argument at hand.

The report, little more than a deck of PowerPoint slides, starts out by showing potential savings based on projected productivity gains. The consultants assumed 7% annual productivity gains to get to the $125 billion, whereas 3% annual gains only get you $60 billion in savings. Why 7% productivity? Because private sector industries "commonly show similar gains." Never mind the fact that economists generally agree that productivity has been flat for years. The industry benchmarks used in the report are not representative of defense support activities. Productivity in "office supplies, stationary, and gift store" is not representative of productivity in defense, even if they are DoD inputs. Moreover, there is no generally acceptable way of measuring productivity in the DoD, even for support functions. This is because the defense "marketplace" is only a loose facsimile of the kind you read about in economics text books.

Supposing that the DoD could achieve 7% productivity gains, how would the consultants recommend the DoD gets there? Productivity gains amounting to $46-89 billion can be achieved through "contract spend optimization" which requires more rigorous vendor negotiations, aggregating spending to gain economies of scale, increasing productivity, and eliminating "gold plating." This is basically all they had to say on regarding half of the total savings. The supposedly specific and actionable recommendations merely restate the objectives of existing job functions. For example, to anyone familiar with defense vendor negotiations, it is hard to believe that regulations on contracting officers could get any more rigorous. Lawyers are brought into the discussions at ever earlier stages in preparation for award protests. In short, the recommendations are empty.

In almost all cases, productivity gains were implied by consolidating information technology (IT) infrastructure and leveraging its output, big data. But even smaller firms find implementing IT solutions difficult, fraught with unforeseen challenges and cost overruns. Striving for bigger and better data is often a fool's errand, even for relatively simple operations.

An early example of the DoD implementing streamlined IT efficiencies came during the Korean War. The Munitions Board attempted to centralize the inventory data of machine tools using IBM punch cards to optimize allocations. The attributes of each machine were recorded and contractors could read the cards to locate their tools instead of doing on-site inspections. But machine tools are more complicated than the Munitions Board had assumed. The IBM cards completely failed to convey important nuances in machine tools leading to expensive errors and lost time. The initiative and countless other more like it sought to strip away complexity and replace it with the pristine order that consolidation imposes.

The out-sized share of the PowerPoint went to specific discussions on IT consolidations, whereas the consultants hand-waved issues of contracting and civilian fringe costs. This is concerning because the Task Group Chair, Mr. Phil Odeen, also has positions at Booz Allen Hamilton and Globant, both of which are IT services providers. According to the meeting minutes, he did most of the talking. Was the report a well-intended set of recommendations, a business pitch, or both?

The easiest way to see that the consultants were blowing smoke comes at the end. They write that "Technical solutions... will not, by themselves, achieve the savings." The technical solutions are a tool that must be supported by a culture change. For example, there needs to be "strong, consistent top leadership," "clear decision-making authority" and "defined accountability at all levels." Here, the consultants pay lip service to what really matters, and reference their earlier work on culture change. The only problem is that their conclusions are antithetical to all present discussions on defense reform!

The consultants want more centralized planning and more rigorous regulations. Congressional leaders, such as Rep. Mac Thornberry and Sen. John McCain, are calling for decentralization and fewer regulations. Legislation is being discussed would devolve some of the planning and programming decisions from AT&L down to the services. Further, AT&L itself may decentralize, separating its R&D functions from acquisition and logistics. The Pentagon is in the awkward position of being pulled in two directions.

Yet being pulled in two directions is par for the course in the Pentagon. For example, the landmark 1986 Goldwater-Nichols Act attempted to decentralize operations, but, as Rep. Thornberry said, it "unintentionally fueled a runaway, outmoded bureaucracy." The public should take little solace, however, that any prospective legislation would turn out differently. As scholar Fred Thompson found, decentralization requires giving operating managers the "maximum authority feasible, or, in the alternative, subjecting them to a minimum of constraints." But Congress doesn’t trust the lower echelons and wants to increase constraints! For example, the legislators want binding unit cost and schedule targets earlier in the acquisition process, at Milestone A, which is at initiation of Technology Development or prototyping. (Note that the troublesome F-35 went through a Milestone A equivalent in 1996. Certainly that is too early to smooth over programmatic risks with extensive before-the-fact controls.)

Ultimately, one must acknowledge that the fundamental principles of complex operations are decentralization, redundancy, and self-organization. While policymakers admit the inherent complexity in defense and claim they desire to decentralize operations, they shy away from actual implementation because of its superficial illogicalities. Hence they attempt to centralize, eliminate duplication, and control operations through extensive regulations. While in many ways it mirrors the de facto way of doing business in the 1940s and 1950s, a return to direct budget appropriations to decentralized operating units who are controlled using after-the-fact evaluations would go a long way to effecting real defense reform.

But such decentralization means a loss of coherence at the top. It means you should be not expect a reasonable answer from seemingly simple questions. Sen. McCain, for example, fumed that "The DoD cannot tell us how many civilian contractors they employ, no one knows how many people work for the Department of Defense." While that line was trumpeted around as a clear indication that the DoD didn't have its management in order, one has to sympathize with the poor analyst in some cubicle in the Pentagon who knows that the data are flat out not there, nor should they be. Just for starters, are we talking about direct charging workers from prime contractors, or down to the second tier, or third, or fourth, and so forth? Do we include indirect workers? Or which types of indirect? Are we talking physical headcounts or full-time equivalents based on hours charged? The analyst would think, “For there to be any chance of having a clean answer at my fingertips, it would require far more comprehensive cost controls.” The Senator incentivized defense officials to cover themselves with more centralization and new regulations at the same time he cried that the DoD is too centralized and bloated with regulations.

The answer turned out to be about 740 thousand. But the better question is whether that matters. Is there any basis for judging 740 thousand contractors as too high or too low, even if the number were not arbitrary in some sense? The Sen. McCain’s statement makes clear that he views the defense enterprise as a vast administrative problem, where decentralized operations can be neatly aggregated to inform policy. In this way, the Senator champions the utopian view of consolidation and big data at the same time he champions decentralization and competition. At least the consultants who would save $125 billion on baseless assumptions were consistent, if shallow, in their views.

Defense Reform 2016?

Congress again returns to a beloved topic, defense reform, and its policy lineup lacks any thought or imagination.

For now, let's examine the appeal of decentralization. Rep. Mac Thornberry believes that this is done by allowing the services to have more say in planning and programming through an increased role on the requirements generation and acquisition milestone processes. He also would like to break up his staff in OUSD(AT&L) by bringing back the Director of Defense Research and Engineering (DDR&E).

Note there are two "decentralizations" going on.

First, there is a decentralization of power from the OSD staff to the operating services. More decisions will be made by service executives than staff. The focal point of decision making on the services will resemble a weakened form of what had existed between 1949-58 and 1969-86.

Second, there is decentralization in the OSD staff itself. OUSD(AT&L), which is in the line of command but not an operating unit, was itself the product of a merger between DDR&E and manpower and installations functions from Goldwater-Nichols in 1986. Where decision making focuses on the OSD staff, they inevitably will come down to the detail of operations, requiring greater scale and specialization. This process grows staff into a hierarchy within a hierarchy.

The old myth of the staff had it that it that staff wasn't an operating unit, nor in the line of command. It collecting information, advised, and evaluated on behalf of the commander, and had no authority of its own.

However, with the 1958 Reorganization Act, DDR&E was created in order to bypass the long chain where lower echelons in the staff have to run up to the Secretary of Defense and then back down the appropriate chain in the services. The staff to the Secretary gained "legal" authority to exercise power over directing the services.

While the services are mission oriented with their own straight-line hierarchies, the staff is organized functionally. The functions, such as R&D, logistics, etc., are shared by all missions. Numerous lines of command in the staff have authority affecting operating decisions in the service hierarchy but no responsibility for the resulting outcomes.

This is how you get, as Admiral Rickover once lamented, a six month delay "just because one staff person with no responsibility but with authority had on his own decided that the policy was wrong."

What is ironic is that the second decentralization, fragmenting OUSD(AT&L), doesn't really appear to be reducing its overall power. While it reduces its authority in some aspects, which are devolved to the services, it appears that the strong mandate pursued by DDR&E will provide it new areas of authority which, by being out front of the acquisition process, might grow those areas.

Assisted Return

When I was in Oslo last week I noticed interesting government advertisements on their metro system. The same message was repeated in various languages, stating "Assisted return. Apply now. New rules from September 1." Not much else needed to be said by the Norwegian Directorate of Immigration (UDI) as the intent was clear -- we'll pay you to get out.

Euro-style American Colonization Society

Immigrants makes up 15.6% of the population in Norway as of the beginning of 2015, including children born in Norway to two immigrant parents. Roughly half (though quickly decreasing half) of these immigrants are from neighboring European countries, including Sweden, Estonia, and Poland.

In the abstract, I tend to like the idea of open boarders as a way of improving people's lives and economic productivity. But it is clear that even with many open minded people and state support, volatility and resentment will rear its ugly head.

The first thing that came to mind upon seeing the Oslo poster shown above was the similarities to the old American Colonization Society (ACS). The purpose of the ACS was to free black slaves and repatriate them to Africa, which help founded the colony (and modern day country) of Liberia in 1821.

"Enlightened" gentlemen such as Thomas Jefferson were major proponents of this movement, even going so far as to raid the Virginia Literary Fund to find money for such ventures. I will look for the citation, but this fact struck me hard as an undergraduate taking Virginia History. Jefferson was known, however, for using the Virginia Literary Fund for his own projects.

"On February 21, 1818, the Virginia legislature passed "An Act Appropriating Part of the Revenue of the Literary Fund, and for other Purposes," which set aside $45,000 annually to support elementary schools and $15,000 annually to support the University of Virginia[....] The annual amount appropriated under the Act was insufficient to meeting the University's construction costs."

  An act passed the following year gave UVA the power of the Literary Fund's purse, it:

"gave the Visitors [of UVA] the authority to draw money from the literary fund, and to regulate the tuition fees paid by students and the amount of rent charged for occupying the University's student dormitories. The Professors received a standing salary drawn from the Literary Fund endowment."

The Literary Fund originally had 25% of its budget siphoned off for UVA, which soon expanded so much as to effectively end Virginia's public elementary school system. The Literary 'Slush' Fund could then be used to support the American Colonization Society.

Paying to remove "less desirable" neighbors is the natural solution for the racist who finds himself conflicted with personal ideals about human rights. Germany's openness for refugees may be genuine, but I'm afraid such assisted return programs will be the first step in a degenerative bout of xenophobia.

The Good Job

"One theme that I found especially intriguing in the Mokyr, Vickers, and Ziebarth argument is how some of our social attitudes about what constitutes a "good job" have nearly gone full circle in the last couple of centuries. Back at the time of the Industrial Revolution in the late 18th and into the 19th century, it was common to hear arguments that the shift from farms, artisans, and home production into factories involved a reduction in the quality of work. But in recent decades, a shift away from factories and back toward decentralized production is sometimes viewed as a decline in the quality of work, too.

That was from the timeless Timothy Taylor. And this:

"There is clearly a kind of rosy-eyed nostalgia at work about the qualities of jobs of the past. Many of us tend to focus on a relatively small number of past jobs, not the jobs that most people did most of the time. In addition, we focus on a few characteristics of those jobs, not the way the jobs were actually experienced by workers of that time."

A Fiscal Scenario By Any Other Name

Paul Krugman: "I wrote Monday about the strange phenomenon of Republicans lining up to propose cuts to Social Security, a deeply unpopular policy that is, however, also a really bad idea. How unpopular? Lee Drutman has the data: only 6 percent of American voters support Social Security cuts, while a majority want it increased. I argued that this apparent act of political self-destructiveness probably reflected an attempt to curry favor with wealthy donors, who are very much at odds with the general public on this issue:..."

Regardless of whether the Republican cuts are ill-designed or voters overwhelmingly support increasing benefits, earned benefits have to be on the table for the U.S. to be able to meet its future obligations. The National Debt is over $18tn, but Laurence Kotlikoff states the true fiscal gap as measured by the present value of expected future taxes less expenditures is over $200tn. He goes on:

"[There is] irresponsible behavior on the parts of politicians of both sides who are trying to get the elderly's vote. When President Bush introduced Medicare Part D, which is prescription drug insurance for the elderly, [he added] another $15 trillion to the fiscal gap. He didn't ask a single old person, including Warren Buffett, to pay a penny for this extra form of social insurance.

...So a lot of people like to portray this as the Right vs. the Left, the poor vs. the rich, but it's really adults vs. children."

Like Kotlikoff, I believe in social safety nets. but something that can't go on won't. The Congressional Budget Office is apparently more concerned than they let on. The CBO produces two fiscal scenarios:

 "they put out what's called the 'Baseline Extended Budget Forecast,' based on forecast which is a complete fabrication of what they really think; and they also have put out, but rather quietly, this 'Alternative Fiscal Scenario,' which shows the official debt, as it's currently measured, exploding through time."

The nation's fiscal situation is similar to Detroit, but it has the benefit of the Federal Reserve to buy more time. One has to address the elephants in the room -- Social Security, Medicare, defense, tax policy (and of course Planned Parenthood).

One important item not often addressed is the Homeowner Tax Credit. Not only is it an expensive program (in foregone revenues), but it distorts the housing market. Yet it is a program with such momentum that pulling the plug will lead to foreclosures because those benefits are now priced into the market. Further, the Tax Credit subsidizes interest payments instead of down payments, and therefore households are incentivized to take on more debt.

The Homeowner Tax Credit was a political, not an economic, policy. This helps to create a vested interest with a broad base (both Republicans and Democrats own houses). 

The same is true for earned benefits. Now this doesn't mean that these policies don't attempt to achieve desirable ends or their principles should be abandoned. But we do need to recognize when one generation expects to get out far more than they put in. We need to recognize that what is prudence in the conduct of every private family can scarce be folly in that of a nation. No parent would leverage their children's future earnings to increase their own income with the understanding that it will be impossible for the child to recover by doing the same to the next generation.

Quality Choice and Net Neutrality

The net neutrality question is one that has been of particular interest of recent, and government policy in this area has many complex repercussions. In short, internet service providers (ISPs) can either provide the same quality service to all content providers at a flat rate (the status quo), or provide a range of qualities and corresponding prices. Much of that debate will not be discussed here. 

The purpose of this post is to evaluate the circumstances of net neutrality in one specific context: where the ISP is an assumed monopolist and can choose provide an array of service quality contracts at differing prices. The consumers then self-select and reveal their preferences based on the contract they choose. It will be assumed throughout that the profit maximizing monopolist has a marginal cost of zero for providing any quality service.

It is clear that should all consumers have the same preferences, the monopolist would choose the one quality/price pair that maximizes profits. If consumers had differing valuations but the monopolist had perfect information on this, then the monopolist would act as a perfect price discriminator (assuming no arbitrage). In either case, the monopolist would charge where the consumer’s marginal value for quality equals marginal cost (zero) and earn the total consumer value. 

             

More realistically, the monopolist does not know consumer valuations. Let’s start by assuming that there are two types of consumers: Low-Types and High-Types. Low-Types value may range from 0-100% of the High-Types and we assume that each group represents half the population. The general result is that when the Low-Types value a good at less than or equal to 50% of High-Types, the monopolist maximizes profits by driving the low-quality good down to zero, or taking classic monopoly profits on the High-Types alone.  

The pair of charts below depicts this situation. Left Chart: the monopolist would like to choose the low-end quality that maximizes their profits (choose X-coordinate at a function's peak). Right Chart: for a profit maximizing quality choice, how much of the total consumer value is being captured.
 

In instances where Low-Types value a good greater than 50% of the High-Types, it benefits the monopolist to keep a lower-quality good in the market. As Low-Types values converge on the High-Types, the optimal low-quality also converges on high-quality. Again, this is the case only when there are an equal number of Low- and High-Types.

We may also vary the distribution of each consumer-type to see how our answer changes. The chart below fixes the Low-Type value to half that of the High-Type, but changes the weighting of group size. The black line is where there are equal numbers of Low and High-Types. One can see that should there be a high proportion of Low-Types, the low-quality converges on the Low-Types value and it is optimal for the producer to attempt a monopoly in that market. 

Instead of charging the High-Types where their marginal benefit equals marginal cost, the preponderance of Low-Types makes it more profitable for the monopolist to extract all the welfare from the Low-Types. Should Low-Types have a value 30% or 70% that of the High-Types, the monopolist's optimal low-quality will be 30% and 70%, respectively, of the high-quality. Not surprisingly, relatively many High-Types tend to drive the low-quality good out of the market so the monopolist can extract the High-Types’ entire welfare. 

 

Within our context, these results help inform an opinion on the net neutrality debate. The types of quality provided depend on the distribution and intensities of consumer valuations. Where there are many High-Types, or Low-Types perceive the good/service to be far less valuable than the High-Types, the monopolist will tend to drive the low-end quality downwards and often out of the market. 

Large internet content providers, like Netflix, YouTube and Google, tend not only to demand high quality but use the ISP service more frequently as well. Their revenue generally depends on internet-user traffic. The faster the service, the more likely the website will retain or increase traffic relative to competitors. Therefore, these “High-Type” content providers would be keen on acquiring higher quality service if only to not lose market-share.   

Those who are “Low-Types,” perhaps because they cannot afford it, may see their traffic diminish due to low quality and find their relative market position worse than it was before. If low quality service is driven out, then the “Low-Type” content providers will simply leave. This outcome would appear most undesirable. More likely is that there will be a mandatory minimum quality; such a policy would alleviate the worst of these outcomes despite its distortions. On the other hand, if it turns out that Low-Types share of internet traffic is high, or that Low-Types value the service quite highly, then social welfare may be increased by abandoning net neutrality. 

I tend to believe that the vast majority of websites see very low traffic and have low willingness to pay for high quality service relative to the internet giants, suggesting net neutrality may benefit diversity and competition.

Navy Corruption Scandal

"Between September 2011 and June 2012, GDMA submitted 117 fake bids for incidentals to the Navy’s pricing database—for one port alone. But those 117 incidents comprised only 35 unique bids. GDMA would often just resubmit the same fraudulent pricing quotes over and over again.

And remember, those [117] quotes were just for one port for a short period of time. GDMA has been doing the same at dozens of ports for years.

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A typical example of this kind of corruption is what the GDMA did to the Navy in Thailand.

American ships require fuel with no biodiesel content. The DLA didn’t have any relationships with fuel vendors in Thailand, so the Navy asked GDMA to see if Bangkok could provide the fuel.

“[Fuel] is unavailable due to Thailand’s regulation that diesel in the country must have a biodiesel content mix which does not meet [Navy] requirements,” GDMA explained in forms provided to the Navy. “GDMA will provide [the Navy with fuel] from its own stocks which are imported and contain no biodisel.”

It was a lie. Bangkok had no regulations requiring a biodiesel mix. So GDMA bought the fuel from local suppliers, then sold it back to the Navy … and not at cost, as its contract required. GDMA overcharged for every gallon of fuel it sold to American ships.

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Any time ships from the Seventh Fleet docked in Thailand, GDMA would take care of the tariffs, then use a fake company to bill the Navy at exorbitant prices.

GDMA billed the Navy about $300,000 when a ship docked at the port of Laem Chabang in Thailand. Prosecutors in the case went back through the Thai port authority’s Website, cross referenced the tariffs charged at the time and got the real total.

The Navy only owed $35,000 for the Seventh Fleet ship."

That was from War is Boring. A Justice Department report is here. And this is how they got away with it for so long:

"Of all [the] cronies, NCIS supervisory agent John Bertrand Beliveau was [the] most important. Beliveau was [GMDA]'s man inside the criminal investigative wing of the Navy. Thanks to the agent’s efforts, [GMDA] was able to stay one step ahead of investigators for years."