A Real Economy publication

Government contracting outlook: Summer 2022

May 18, 2022

Government contracting outlook key takeaways

government building icon

Geopolitical volatility and domestic opportunity underscore the importance of resilient supply chains and agile processes.

Scales icon

The Russia-Ukraine war exemplifies how spurts of demand can manifest quickly and reward adaptability.

government seal

Domestic spending initiatives and priorities should amount to opportunities for government contractors.

#
Government contracting Economics

For government contractors, agility is a virtue amid uncertainty abroad and opportunity at home

Government contractors find themselves in a period being shaped by significant geopolitical conflict, collaboration among allied nations, and heightened alert to protect the homeland. Defense contractors are juggling current domestic and international demand while positioning for the future of defense. Many civilian agencies, meanwhile, are strategizing around future opportunities that align with the Biden administration’s climate and public health priorities.

A geopolitical surge

The United States’ support for Ukraine has strengthened since Russia invaded on Feb. 24. Two rounds of military and humanitarian aid through mid-May totaled approximately $53.4 billion, the largest amount Congress has approved in at least two decades.

The Senate on May 19 approved a package of nearly $40 billion, which exceeded the $33 billion President Joe Biden had requested. It included $6 billion for security assistance in the forms of weaponry, intelligence, logistics and training; $8.7 billion to replenish U.S. stocks of equipment sent to Ukraine; and $13.9 billion for the State Department to devote to humanitarian and economic aid.

That package followed one totaling $13.6 billion in mid-March. Direct transfers of equipment from the Department of Defense have included a variety of defense systems and supplies—from armor and helmets to Javelin missile systems and unmanned aerial systems. The United States also has provided support in the form of satellite imagery and analysis capability, secure communication systems, helicopters, patrol boats, and other systems and supplies.

To put those expenditures in perspective, they far outpace annual U.S. government foreign military sales to Ukraine over the past five years. According to the Defense Security Cooperation Agency, U.S. government foreign military sales to Ukraine ranged from $208 million to $511 million per year over the period. Those figures capture formal contracts and agreements between governments as authorized by the Arms Export Control Act of 1976, negotiated either via the DOD directly or via DOD-managed contractors. 

Past U.S. military sales to Ukraine vs. 2022 wartime aid chart | Architecture and engineering industry trends
Past U.S. military sales to Ukraine vs. 2022 wartime aid

Defense contractors involved in producing the systems the Ukrainian military needs and desires most met with Pentagon officials on April 13 to strategize around continued production and support if the Russia-Ukraine war extends. This could challenge contractors if the systems needed by Ukraine are dated or not currently a focus of preexisting production targets. A geopolitical conflict such as this one is a reminder to contractors that in a volatile world, spurts of demand can manifest quickly, and they should continue to invest in making their supply chains resilient and agile. 

International demand in flux

U.S. worldwide foreign military sales, in aggregate, have declined the last three years, totaling $34.8 billion in fiscal year 2021, down from totals greater than $50 billion in fiscals 2018, 2019 and 2020. Does this signal a long-term downward trend in international demand? Not necessarily. It is likely that international government budgets were squeezed by local public health needs to fight the coronavirus pandemic. 

U.S. government foreign military sales chart | Architecture and engineering industry trends
U.S. government foreign military sales

Plus, recent events could catalyze demand. Recall that NATO in 2014 set for each member country a defense spending target of at least 2% of gross domestic product by 2025. As of today, only a handful of member countries have achieved this target. But Germany announced in February 2022 an intention to target the 2% GDP guideline after spending approximately 1.49% in 2021. This increase and the possibility of other countries following suit signal increased demand in 2022 and beyond.

In 2021, the United States exported the most military systems and equipment to Japan ($3.9 billion), the United Kingdom ($2.9 billion), Taiwan ($2.7 billion), Canada ($2.6 billion) and Egypt ($2 billion). Historically, some countries, such as Japan, have maintained steady demand based on defense strategies and long-term supply relationships with allies. The data also shows large swings in military sales in particular years. They were commonly driven by large one-off purchases, as well as changes in demand due to strengthening relationships or changes of control, like decreases we expect to see in Afghanistan, a country now under Taliban control. 

According to the Stockholm International Peace Research Institute, U.S. arms exports accounted for 39% of all arms exports between 2017 and 2021. This is 14% higher than what occurred between 2012 and 2016.

According to Bloomberg, overseas sales are approximately 25% of revenue for the top five U.S. prime contractors. During Raytheon Technologies’ Jan. 25 earnings call, CEO Gregory Hayes predicted a recovery of the company’s international defense business, citing a book-to-bill ratio “well north of 1.0” moving into 2022 and beyond. Similarly, L3Harris Technologies Vice Chair and CEO Chris Kubasik noted during a Jan. 31 earnings call that he expects to see continued international demand for defensive solutions that are aligned with U.S. export and national security policies.

While all nations are working toward a global recovery and are in various stages of the pandemic, emergence from it may bring the return of conflict and a rebounding need for physical security.

$1.6 billion 

Total U.S. military sales to Ukraine from 2017 to 2021

14%

Percentage by which the United States’ portion of global arms exports increased between 2017-2021 compared to 2012-2016, according to the Stockholm International Peace Research Institute 

11% 

Increase in nondefense spending in President Biden’s 2023 budget request

Back-to-back omnibus and budget

March 2022 brought us a fiscal 2022 omnibus spending bill and fiscal 2023 presidential budget request in succession.

Congress passed the fiscal 2022 omnibus spending bill that included $1.5 trillion of discretionary spending, reflecting 5.6% and 6.7% increases in defense and nondefense spending, respectively. This bill included $13.6 billion of emergency funds for Ukraine, $1 billion in disease research funds for Biden’s Advanced Research Projects Agency for Health, and a 10% increase for Department of Energy climate-related initiatives, according to Bloomberg Government.

This package also brought back earmarks for the first time since 2011. Most notably, by passing the fiscal 2022 omnibus, Congress fully funded the Infrastructure Investment and Jobs Act, allowing new infrastructure programs to officially kick off.

At the end of March, the market also got a glimpse of Biden’s wish list via his fiscal 2023 budget request. The request totals $5.8 trillion, with $1.6 trillion of discretionary spending. The administration’s climate, health and domestic manufacturing priorities can be seen across agencies within the request, with defense spending increasing 4% and nondefense 11%.

The president’s budget request serves as an initiator for the fiscal year budget process as Congress begins its hearing and markup processes. Congress’ first point of contention with the budget is the embedded assumption that inflation will drop to 2.3% in 2023 and remain at that level going forward. With top-line core inflation data increasing 1.2% in March to 8.5% on a year-ago basis, 2.3% appears quite aggressive.

As usual, contractors should review the president’s budget request as no more than a directional indicator of the administration’s priorities and preferences. Congress’ version of the federal budget that ultimately passes could vary widely from this request. A variety of factors will influence lawmakers, including 2022 being an election year, the possibility of extended geopolitical conflict across the globe, and inflation trends over the coming months. Contractors should monitor Congress’ progress toward a fiscal 2023 budget but keep in mind that the budget process hasn’t been completed on time since the 1990s.

The takeaway

For government contractors, the current combination of geopolitical volatility and domestic opportunity underscores the importance of resilient supply chains and agile processes. Meeting domestic and international demand while pursuing the future of defense requires vigilance, savvy and adaptability. Opportunity abounds for contractors serving both defense and civilian agencies as the United States looks to support its citizens and allies during a period of significant economic and geopolitical uncertainty.   

RSM contributors

Trending insights in government contracting

The Real Economy

Monthly economic report

A monthly economic report for middle market business leaders.

Industry outlooks

Industry-specific quarterly insights for the middle market.