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p The expansion of the specialised private military sector of the economy went hand in hand with the development of a definite regulation system in relations between the government and private business, of the methods for stimulating military production.

p In the scheme of relationships between the government and private military corporations it is necessary to single out the system of military contracts and the formation of military goods prices, the two levers by which the government regulates the development of military production.

p Military Contracts. The relations of the Administration with private firms are based on contractual principles. It is precisely through a system of contracts that the government orders the required military products, specifies their quality and structure, as well as the place of their manufacture.

p During the Second World War, the government’s relations with private suppliers were normally based on the following principles. The Administration procured the greater part of armament units and parts and military equipment directly from suppliers and handed over these components to the main assembly enterprises manufacturing end-products. Under this system, government procurement agencies signed contracts and maintained direct connections with almost all military suppliers.

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p After the war, the Administration gradually changed over to another system, more and more often signing contracts only with prime contractors obliged to develop and produce military goods under a given contract. The prime contractor usually fulfils the most important part of the contract, handing over the remaining part to subcontractors which, in turn, transfer a considerable part of the subcontracts to subcontractors of a "third order”, the latter to still smaller concerns, etc. The prime contractors are responsible to the government for deliveries of military endproducts—missiles, aircraft, etc.

p Under this system of procurement the government hands over a considerable part of its contract supervising functions to the prime contractors. The latter enjoy greater freedom in supervising military orders, in selecting subcontractors and subsuppliers. Procurement agencies of the armed forces only control and co-ordinate the work of suppliers. Even this, however, causes discontent of the arms-manufacturing monopolies aspiring to full freedom of action.

p Another practice is one of "joint contractors" undertaking basic deliveries of large components of weapons systems, for example, engines, radar units. Under this system, no company is appointed to direct the fulfilment of a contract for the entire weapons system. The assembly and testing of weapons are carried out by one of the "joint contractors”.

p Prime contractors for aircraft and missiles are usually chosen among companies producing the main structure of an article; for warships, the yards; for combat vehicles, motor companies. The prime contractor is responsible to the government for the fulfilment of a military contract whereas the subcontractors supplying units, parts, components or raw materials are responsible to the prime contractor.

p Military contracts are subdivided, according to the method of distribution, into contracts signed on the basis of wide competitive bidding and contracts signed behind closed doors, i.e., in direct negotiations between procurement agencies of the Defence Department and private corporations.

p Until 1947, the only legal method of signing military contracts was competitive bidding, both secret and public. 195 The Armed Services Procurement Act of 1947 lifted this restriction and gave the armed services full freedom in choosing the form of making contracts save for "cost- plusa-percentage" contracts which were specifically forbidden as ineffective. When he signed the Act of 1947, President Truman wrote to the Secretary of Defence, "This bill grants unprecedented freedom from specific procurement restrictions during peacetime".  [195•1 

p This "unprecedented freedom" of the Defence Department was widely used by the military-industrial complex in its interests. Those types of contracts which ensured the highest profits for the monopolies became the most sought after. This is one of the main reasons for the overwhelming share of military contracts being concluded behind closed doors, i.e., without announcing them in the press, the Pentagon’s agencies directly selecting suppliers of the required goods and services. In the period 1951-65 the Defence Department signed more than 357,000 million dollars’ worth of contracts, of which only 13.7 per cent worth 49,000 million dollars were signed on a competitive basis, whereas the remaining 86.3 per cent worth 308,000 million dollars were signed behind closed doors.  [195•2  Almost all purchases of missiles and aircraft were made in secret; in this sphere, competitive bidding accounted for only one per cent of all contracts.

p The need for closed-door bidding is largely motivated by such factors as the limited number of specialised firms capable of quickly manufacturing definite high-quality specimens of sophisticated weapons systems, the specific features of military production, observance of secrecy, etc. If it were not for profit-chasing, however, the share of secret contracts would have been much smaller than it is. The point is that these contracts make it impossible for the Administration to take advantage of competition, and give much freedom for abuse both on the part of government officials signing contracts and corresponding corporations. As a result, secret bidding leads to procurement of military supplies at exorbitant prices.

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p According to estimates of the US General Accounting Office, when concluding non-competitive contracts the Defence Department loses an average of 25 cents per dollar of spending, which amounts in the aggregate to a tremendous sum. The Pentagon’s procurements under direct negotiations in the period 1951-65 were worth 308,000 million dollars. It may be calculated on this basis that the sums the Pentagon forfeited over the period through the absence of competition in signing contracts amounted to about 77,000 million dollars, or an average of 5,400 million dollars annually.

p To reduce these colossal irrational expenditures, the Defence Department has carried out considerable work to reduce the share of non-competitive contracts in favour of competitive ones. In the event of competitive bidding, the Pentagon’s intention to buy or order concrete goods and services is announced in the press in advance. Then the suppliers are chosen and contracts concluded with those of rival firms offering their services whose terms are more acceptable for military agencies. As a result of these measures, the share of competitive contracts in the total value of military contracts grew from 14 per cent in 1959/60 to 47 per cent in 1966/67.  [196•1 

p Price Formation on the Military Market. A distinctive feature of price formation on the military market is the fact that prices of military goods are set not by the laws of the free capitalist market but at the talks between representatives of government procurement agencies and private suppliers. Under the operating system of payments for military supplies four basic types of contracts are used:

p 1. Cost;

p 2. Cost-plus-fixed-fee;

p 3. Firm-fixed-price;

p 4. Incentive type: (a) cost-plus-incentive-fee; (b) fixedprice-incentive.

p Under the cost contracts, the contractor is reimbursed for all expenses involved in fulfilling a military contract. Such contracts are usually made with higher educational establishments and other “non-profit” research institutions. 197

p Under the cost-plus-fixed-fee contracts, contractors are reimbursed for all authorised expenses involved in fulfilling military contracts and, in addition, are paid a fixed fee (profit).

p Introduction of cost-plus-fixed-fee contracts was largely due to the rapid increase in the Pentagon’s procurements of the share of the latest types of weapons and military equipment for whose development and production corporations had neither experience nor appropiate research and production facilities. Therefore, the Defence Department, in an effort to interest firms in the production of sophisticated armaments, was compelled to guarantee them against possible losses through a price-formation system based on the cost-plus-fixed-fee principle. However, the wide spread of such contracts was also due to their being highly advantageous for monopolies manufacturing military goods. As a result, the share of these contracts in the total of prime contracts (in terms of value) grew from 8.6 per cent in 1951 to 34.3 per cent in 1959.  [197•1 

p Contracts repaid on the cost-plus-fixed-fee principle are the most extravagant and ineffective. They guarantee payment equally for good and inadequate work of the supplier. What is more, these contracts far from stimulating better work of suppliers in the way of reducing production costs and prices, lead, on the contrary, to an artificial inflation of outlays because under this item the contractor is reimbursed for all expenses reported, and guaranteed a fixed fee irrespective of the efficiency of his work.

p These contracts are conducive to artificial price rises through a system of subcontracts, which results at times in multistage contracts with hundreds of successive subcontractors. Using the system of subcontracts, prime contractors greatly overstate their outlays, including therein expenses and even profits of subcontractors, and this enables them to increase their own profits also through outlays made by subcontractors. In this way, both subcontractors and prime contractors derive profits from one and the same work involved in fulfilling a contract, i.e., a veritable "pyramid 198 of profits" is formed, as was stated by the McClellan Committee in September 1962.

p As a result of these and other drawbacks in the system of calculation of all the elements of spending on arms production, actual payments for military programmes fulfilled are sometimes 3-10 times the initial estimates.

p The proportion of cost-plus-fixed-fee contracts in the total of contracts reached an all-time high in 1960/61 when it rose to 38.9 per cent as against 19.7 per cent in 1954/55.  [198•1 

p After a long study of the system of distribution and payment under military contracts the Defence Department issued in March 1962 a supplement (No. 8) to Armed Services Procurement Regulation which denounced cost- plusfixed-fee contracts and emphasised that the best type of contracts was that stimulating contractors to reduce military production costs.

p According to these principles, the best contracts are admittedly those based on firm fixed prices (i.e., with deliveries repaid at prices stipulated in advance). In this case, a contractor has an incentive to reduce production costs because he retains all additional profit. There are cases, however, where firm-fixed-price contracts cannot be secured for a number of reasons, for example, owing to the impossibility to reckon the final cost of an order. In such cases the Defence Department employs various types of incentive contracts stimulating contractors to reduce production costs, and improve the quality and scheduling of arms supplies.

p For several years now, the Pentagon has been implementing practical measures to replace the ineffective costplus-fixed-fee contracts with the more preferable fixedprice-incentive contracts. As a result, the share of cost- plusfixed-fee contracts reduced to 20.7 per cent by 1962/63, and further to 10.4 per cent by 1967/68. The share of fixed- priceincentive contracts grew from 14.4 per cent in 1960/61 to 26.1 per cent in 1967/68.  [198•2 

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p Replacement of cost-plus-fixed-fee contracts by fixedprice-incentive contracts cuts procurement prices by 10 per cent on the average.  [199•1 

p Under fixed-price-incentive contracts the prices of goods to be supplied are agreed on in advance, which eliminates the above-mentioned drawbacks of cost-plus-fixed-fee contracts. Moreover, when signing such contracts, contractors are faced with definite additional tasks (reduction of production cost, improvement of tactical and technical characteristics and reliability of weapons, punctuality of execution of an order and of deliveries, etc.), which provides material stimuli for more efficient work by contractors deriving an additional fee varying with the degree of fulfilment of these tasks. In case production costs have been reduced, 5 to 20 per cent of saved funds is retained by the contractor as an incentive profit, the rest going to the Treasury. If the accuracy of hitting the target by a missile is increased 15 per cent as compared with the initial project, the contractual price may be increased 30 per cent.

p For bad performance (violation of contractual delivery terms, impaired product quality, etc.) contractors are subjected to monetary fines.

Thus, the Defence Department attempts to achieve a relative reduction of the cost of military procurements by making the rate of profit directly dependent on the efficiency of contractors. The Defence Department also takes measures to improve the system of control over the fulfilment of military contracts. For this purpose, the so-called PERT method (Program Evaluation and Review Technique) is used on an increasing scale in two variants: PERT/time and PERT/cost. The PERT/time technique is used to determine the time required for fulfilling every type of work under a given programme and to draw up an integrated operational time schedule. This enables determination of provisional optimum performance rates and the minimum time required for fulfilling the programme as a whole. The PERT/cost technique is used to draw up an integrated operational cost schedule for individual jobs under the programme and to reveal the possibilities for economising.

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p The use of these two techniques in combination makes it possible to establish the conformity of actual spending and scheduling to those estimated beforehand. In addition, efficient organisational and technological measures could be outlined to save time and funds in fulfilling contracts. The PERT technique developed in 1958 began to spread rapidly both in military and civilian industries. It is used on the widest scale in research and development and in construction, and is helpful both to the client (for control over the progress of the work) and to the contractor (for operational planning).

p Until recently, every military department and agency distributed contracts and supervised them independently. Early in 1965, a special centralised body—the Defence Contract Audit Agency—was set up and authorised to audit the contracts of all military departments and agencies.  [200•1  The main motive for instituting it was to give auditors greater independence from those military departments whose contracts they were to examine, as well as to achieve an economy of funds by reducing the number of auditors. Simultaneously a uniform accounting procedure was prescribed for all armed services.

p In this way, the Defence Department, by rationalising the system of distribution of and payments under military contracts, as well as by tightening control over their fulfilment, attempts to enhance the responsibility and efficiency of military suppliers and, in the final analysis, to reduce procurement prices.

p These measures allow saving fairly large sums, but fail to do away with the main flaws in the existing forms of payments for military supplies which result as before in inflated prices of military goods.

p We have dwelled above on those causes of price rises which are rooted in the growing cost and the objective factors of advancement of military technology, the character of military production and its specific features. In addition to these causes, traceable to changes in the production sphere, price rises result from growing inflation and the abovementioned drawbacks in the system of distribution of and payments under military contracts.

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p It is difficult to ascertain how much a price rise is due to production changes and how much to defects in the priceformation system. We believe that changes in living and materialised labour spending per unit product of analogous military items may provide an approximate index demonstrating the degree to which production factors are responsible for price rises.

A price increase roughly correspondent with the growth of labour consumption of products would be a legitimate phenomenon. Actually, however, prices evidently tend to grow more quickly than the labour consumption of military goods, a fact which is due to the general inflationary tendencies and the resultant depreciation of the dollar, as well as to the features peculiar to the sale-and-purchase processes on the military market. This cuts the effectiveness of military spending because the growth of prices unconnected with an increase in the labour consumption and an improvement in the combat characteristics of weapons leads to a situation in which the Pentagon acquires less and less military goods for every dollar spent.