U.S. defense market seen facing rising protectionism

By Andrea Shalal-Esa - Analysis

WASHINGTON (Reuters) - Expected Democratic gains in Congress, a tighter defense budget and growing concern about barriers to U.S. weapons sales in some European countries point to a surge in American protectionist sentiment after the Tuesday election.

That is seen resulting in tighter scrutiny of European companies bidding for a stake in billion-dollar U.S. defense contracts. At the same time, a rising dollar and tighter credit markets worldwide may dampen foreign interest in buying smaller American defense companies.

"For a variety of reasons, it's going to be harder to enter this market or sell into it," said defense analyst Loren Thompson of the Virginia-based Lexington Institute.

Defense officials, industry executives and analysts agree that U.S. defense spending is likely to grow much more slowly over the next four years than it did over the past eight, regardless of whether Democrat Barack Obama or Republican John McCain wins the presidential election. One reason: Congress must find a way to pay for the unprecedented $700 billion bailout package for the U.S. financial services industry.

U.S. defense spending has climbed over 60 percent during the Bush administration, and will total at least $612.5 billion in fiscal 2009, including $542.5 billion for the basic defense budget and $70 billion for the wars in Iraq and Afghanistan.

Steve Kosiak, analyst with the Center for Strategic and Budgetary Assessments, said weapons programs could be hit relatively hard as defense spending leveled out. That would create more pressure to protect U.S. manufacturers, especially if the U.S. economy remains weak.

"The next administration may also take a more active role in shaping and protecting the defense industrial base. That, too, could result in some additional protectionism," he said.

Analysts say protectionist rhetoric is already on the rise. They cite campaign statements by both presidential candidates, and anti-foreign comments by Boeing Co (BA.N) supporters during the company's protest against a $35 billion refueling aircraft contract awarded to Northrop Grumman Corp (NOC.N) and its European subcontractor, Airbus parent EADS (EAD.PA).

"It's probably going to get worse before it gets better," said one defense official, speaking on condition of anonymity.

Richard Aboulafia, analyst with the private Teal Group, agreed. "The sad truth is that both sides of the political aisle have been back-pedaling on globalization."

EXPORTS MAY TEMPER MOOD

Some U.S. industry executives and analysts argue that the prospect of strong overseas sales -- which help maintain production lines and high-paying jobs at home -- should prevent any moves to reverse globalization in the aerospace sector.

Clay Jones, chief executive of Rockwell Collins Inc (COL.N), a subcontractor to big defense companies, said it was clear that a Democratic-controlled Congress and White House would be more protectionist. But at the same time, efforts to rein in defense spending might actually force the Pentagon to pursue more global development programs like the F-35 Joint Strike Fighter (JSF), he told Reuters in an interview.

Lockheed Martin Corp (LMT.N) is developing three variants of the F-35 with eight international partners, including Britain, at a cost of $299 billion.

"If you're trying to control the rate of defense spending, the JSF arrangement makes a lot of sense," Jones said.