With a historically high federal deficit in FY 2020 and further concerns for this fiscal year, the Defense Department (DoD) may soon face another series of austere budgets. This will kick off the usual fight to preserve programs and elicit pleas to think hard about how DoD spends the next defense dollar. That means now is the time to approach defense spending with a renewed focus on marginal thinking – considering whether an incremental purchase is worth the price – instead of falling into the traps of thinking in terms of “total,” “average,” or worst of all, “sunk costs.”
Thinking on the margin is such a basic economic concept, yet it is underused in allocating defense resources. Too often, discussions about how to allocate resources are dominated by “all-or-nothing,” “take-it-or-leave-it” decisions. Without clear, quantifiable measures to determine the impact to readiness, the contribution to capability, or the reduction in risk, cost often takes precedence in trade-off analyses as benefits are less tangible to decision makers. Often, leaders clamor to ramp up spending to show that they care about an issue without regard to the value those dollars provide or the forgone opportunity to spend those dollars elsewhere. But contemplating the additional value each marginal expenditure yields imposes discipline and improves spending decisions.
This distinct lack of marginal thinking manifests in several ways. Despite robust defense budget discussions and debates, people rarely consider trade-offs within programs. Typically, the focus is on making trade-offs between programs. And, on occasions when examining reductions within a program area, choices come in large, discrete increments: Should we eliminate a leg of the nuclear triad? Divest an entire fleet of aircraft? Completely shed certain mission sets? Forgo security presence in entire regions? Withdraw 2,000 troops? This framing makes the options appear extreme, draconian, and arbitrary. Fine-tuning and optimizing defense spending require more nuanced information and a finer level of detail. Instead, we should focus on defining scalable options with complete cost and benefit information to inform marginal decision-making. And we should stop treating marginal dollars as budget dust — insignificant extra dollars that don’t matter. Considered in aggregate, these dollars comprise billions of dollars of the defense budget.
Consider a few examples where marginal thinking is lacking. In October, the Navy announced its plan to build a 500-plus-ship fleet by 2045 to considerable fanfare. Who is asking how that 500th ship impacts security in the Indo-Pacific region? Why are 499 ships not enough? Why is 501 too many? Could the money spent on the 500th ship add more value if spent on a different capability? And, within the fleet, what is the right number of each type of ship? Then-Secretary of Defense Mark Esper’s comments exemplify where a lack of marginal thinking takes us:
“This discussion often comes down to a binary: Is it zero or 12?… First of all, I don’t know. I think carriers are very important. I think they demonstrate American power, American prestige. They get people’s attention. They are a great deterrent. They give us great capability.”
Carriers cost billions of dollars each: wouldn’t it be good to know the marginal value of the next one we plan to buy? Meanwhile, the Air Force is reconsidering its goal of growing to 386 combat squadrons which was set before the establishment of the Space Force. But, the question of the marginal value of an additional squadron remains. Not all squadrons are the same, so if the Air Force had resources to stand up one additional squadron, what type of squadron would provide the largest marginal benefit?
One major pitfall of failing to think on the margin is the tendency to aim for lower unit costs. The average cost of each item procured can become a focus of attention, especially because nothing arouses ire and attention quite like perceived government waste. But true waste is buying excess equipment merely to hit an arbitrary unit cost target. Consider a notional program which requires $20 billion in research and development costs and an average per-unit production cost of $50 million. If the aim is to achieve a palatable total unit cost of say $100 million dollars (including R&D costs), then produce 400 units. But why stop at $100 million? Save even more money on each unit by making more! Where does it end? If the objective is to lower the unit cost, just keep increasing the number produced. In this example, unit cost could drop to $75 million by doubling production to 800 units. This saves $25 million per unit… at the cost of an additional $20 billion.
Notice anything missing from this discussion? Determining production based on a unit cost objective diverts attention away from what each unit contributes to the overall strategy. It is easy to perform the analysis above or to look for a knee in the curve and presume that is the optimal point. But this is a contrived way to apply analytic rigor. Though difficult, it is much more important to place a value on the marginal contribution that each additional purchase adds to capability. Thinking on the margin requires setting aside the $20 billion in sunk costs spent on research and development and concentrating on whether each additional unit provides strategic benefits commensurate with its marginal cost.
Marginal thinking also applies to personnel decisions. Often senior leaders talk about end strength in increments of 10,000. Roughly speaking, an additional 10,000 service members costs $1 billion. But what is gained from increasing end strength by that amount? It depends. Are these members bringing in applicable, novel skill sets to increase capability in emerging areas? Will this increase fortify the number of people in stressed career fields to reduce the frequency and duration of overseas deployments and alleviate stress from ongoing operations? What does deploying an additional unit to a combat zone bring to the fight? Can the services sustain the additional costs associated with recruiting, equipping, training, and retaining those extra service members? These are difficult but necessary questions to answer.
Thinking on the margin forces us to slow down and focus on the things we can and should control. It demands careful determination and consideration for the additional value of devoting more resources to a program and the sacrifice required when reducing resourcing. It requires rigorous analysis and strong measures of contribution. And, it requires authority to move money to programs that yield the highest marginal returns. The services should articulate the marginal value of each additional unit or weapon system. Compromise is hard when each stakeholder knows that an additional dollar provides some incremental value. But the defense budget outlook calls for hard choices.
This budget season, let’s make articulating marginal value an imperative. Ask what is received in exchange for the next dollar spent in terms of where it could be spent elsewhere.
CSIS does not take specific policy positions; accordingly, all views expressed above should be understood to be solely those of the author. They similarly do not necessarily reflect the official policy or position of the U.S. Air Force, the Department of the Air Force, the Department of Defense or the U.S. Government.
(Photo Credit: U.S. Marine Corps photograph by Chief Warrant Officer 3 Jorge Dimmer, MAWTS-1 COMCAM.)