Original Posting by David Mosher et.al. on July 24, 2023*
As part of the legislative process, the Congressional Budget Office supplies the Congress with cost estimates for legislation, economic and budget projections, and other economic assessments. Information from the research community is an important element of CBO’s analyses. This is the sixth in a series of blog posts discussing research that would enhance the quality of the information that CBO uses in its work. (Earlier posts in the series discussed the need for new research in the areas of energy and the environment, finance, health, labor, and macroeconomics.) Please send comments to communications@cbo.gov.
The Department of Defense (DoD) received about $850 billion in funding in 2023. With those funds, DoD hires personnel (members of the military and civilian employees) and purchases a variety of goods and services from private-sector companies. Some of the purchased goods, such as aircraft carriers, fighter jets, and nuclear submarines, are highly complex weapon systems. CBO is on the lookout for new research on various topics related to DoD’s personnel and weapon systems, including the implications of the military’s use of in-kind compensation and the causes of, and future trends in, sector-specific inflation. CBO is currently working on those topics, and there are significant gaps in the relevant research literature.
The combination of methods DoD uses to attract and retain members of the military and boost productivity—including service commitments, bonuses, annuity payments, compensation on the basis of family status, and in-kind compensation—is unique in the labor market. In addition to using binding contracts, DoD structures pay in many different ways to retain service members with needed skills and to fulfill essential assignments. For example, DoD offers reenlistment bonuses to members in some high-demand occupations. Upon reaching 20 years of service, a member of the military becomes eligible to receive an annuity (after leaving the service) that generally amounts to between 40 percent and 50 percent of their annual basic pay, indexed for inflation. Service members receive a larger housing allowance when they have dependents. And they receive extensive medical care and access to subsidized food stores and recreational facilities.
The way DoD acquires complex weapon systems also differs considerably from the way most goods in the economy are purchased. A small number of companies produce such weapons in a capital-intensive industry with high barriers to entry. There is no private-sector demand for the weapons in the United States, sales to foreign governments are prohibited without DoD’s approval, and in many cases, DoD cannot credibly enforce fixed-price contracts.
What Are the Implications of the Military’s Compensation System?
Naval vessels are a canonical example of a product in a monopsony—a market dominated by a single buyer (in this case, DoD). Moreover, the Navy’s ships are manufactured by a small number of private-sector companies. Each year, the Navy submits a report to the Congress about its planned procurement of ships over the next 30 years. CBO has a legislative mandate to analyze the costs of those plans (CBO 2022, for example).
CBO’s estimates of future shipbuilding costs have been consistently higher than the Navy’s. That is partly because, unlike the Navy, CBO projects that the costs of labor and materials in the shipbuilding industry will continue to grow at a faster rate than prices in the economy as a whole—as they have over the past several decades. Ordinary consumers can often choose substitutes for high-priced products or services, but the Navy cannot. Projections of unending supernormal cost growth in a specific sector of the economy would seem to be out of equilibrium; but such pessimistic projections of shipbuilding costs have been borne out heretofore.
Other parts of the broader economy, such as hospital services and college tuition, have experienced price increases far above the economywide average for many years (Perry 2022). In the service sector, that phenomenon is labeled a “cost disease” (Baumol 2013). It is unclear how long such price increases should be expected to continue. Interestingly, the decades-long rise in health care’s share of gross domestic product may have slowed or reversed: Costs of medical care appear not to have increased as much as the price level of all goods and services in 2021 and 2022, during the coronavirus pandemic (Rakshit et al. 2023). And over the 2009–2019 period, medical prices grew more slowly than economywide prices (Smith, Newhouse, and Cuckler 2022).
CBO’s analysis of the Navy’s shipbuilding plans could be enhanced by additional research that aims to answer fundamental questions about sector-specific inflation in consumer and producer prices. What other economic sectors have experienced supernormal price increases for long periods, and what caused the increases? Are sectors with limited competitive pressures prone to supernormal inflation? In cases in which supernormal, sector-specific inflation ended, what caused it to end?
David Mosher is CBO’s Director of National Security Analysis. This blog post includes contributions from the following CBO staff: Adebayo Adedeji, Scott Craver, Richard DeKaser, Ann E. Futrell, Heidi Golding, Edward G. Keating, Jeffrey Kling, Eric J. Labs, Chandler Lester, and Emily Stern.