WASHINGTON — The Pentagon acknowledged this week a record 40-year-high inflation level is starting to affect contract negotiations, even resulting in a request to cancel a deal.
In a May 2 letter submitted to Republicans in Congress who have criticized the Pentagon’s fiscal 2023 budget for underestimating inflation, Pentagon comptroller Mike McCord as well as the Army, Navy and Air Force secretaries wrote that “some large programs may be insulated from transient marketing pressures because of existing long-term purchase agreements.”
For instance, according to the letter, steel prices for the Navy’s Columbia-class submarines were locked in before inflation started to dramatically increase. As such, rising steel prices are not expected to affect the program much “so long as inflation does not endure too long.”
However, the officials say inflation is beginning to take a toll on new defense contracts, particularly for long-term agreements.
“New contract negotiations are directly impacted by the uncertainty around inflation,” the letter says. “The department is working with all of the buying commands to ensure that there is a common understanding of when [economic price adjustment] clauses are appropriate to protect both industry and the government.”
The officials warn the inflation rate has prompted defense contractors to express concern over entering into long-term agreements. It also says one vendor has requested an economic price adjustment clause for specialty metals, while another has outright requested to cancel an unspecified long-term contract.
They write that the Pentagon and defense contractors must make decisions about the economic price adjustment clauses, which determine the cost of labor and materials in an agreement, early in the process to “inform subcontract negotiations throughout the supply chain.”
Contracts under negotiation “are likely to show price escalation that reflects current market conditions.”
The letter was sent in response to queries on inflation from the top Republicans on the Senate and House Armed Services committees, respectively James Inhofe of Oklahoma and Mike Rogers of Alabama.
Though the officials note “adjustments may be needed as prices fluctuate,” the letter does not ask Congress to increase the proposed $773 billion defense budget for fiscal 2023 — which is $20 billion, or 4%, more than Congress appropriated for fiscal 2022.
“If the Congress increases the topline but directs all the additional resources toward specific programs or program increases not requested by the department, as was the case with the National Defense Authorization Act for Fiscal Year 2022, those increased budgetary resources would not mitigate the impact of higher inflation,” the letter states.
It notes the Pentagon can cope with inflationary pressures on vital items like fuel through its reprogramming authority, but also acknowledges it has not issued any reprogramming requests to deal with inflationary pressures so far in FY 22.
McCord, alongside the chairman of Joint Chiefs of Staff Gen. Mark Milley and Defense Secretary Lloyd Austin, acknowledged last month the 2.2 % inflation rate the Biden administration used to calculate its budget proposal was too low.
Inhofe and Rogers told Defense News the metric the Defense Department uses to measure inflation — the GDP chained price index — is at 6.4% for the first half of FY22. They vowed that the annual defense authorization bill will include a 3% to 5% increase on top of inflation.
“Overall, we are concerned that the Department is not taking a proactive stance to mitigate the harmful effects of inflation,” said Inhofe and Rogers in a statement. “At the very least, they should be collecting necessary data, establishing a governance framework and conducting regular touchpoints with all stakeholders.”
“In particular, it doesn’t seem that the Department has a good grasp on how inflation is hurting our service members and their families — and how this is in turn impacting recruiting and retention,” they added. “Likewise, we are concerned that the department does not have an adequate understanding of the challenges facing the industrial base.”
Bryant Harris is the Congress reporter for Defense News. He has covered the intersection of U.S. foreign policy and national security in Washington since 2014. He previously wrote for Foreign Policy, Al-Monitor, Al Jazeera English and IPS News.