Incentives for government defense contractors
This journal has devoted much attention to such an important problem as the development of arms and military equipment (AME). In the past, under state ownership of the means of production, the administrative-command system ensured the priority of public interests and highly efficient use of funds in the development of armaments. However, the transition to a market economy has brought about a fundamental change in the balance of interests of the parties involved and in the ways of ensuring these interests. The role of administrative methods is declining, whereas methods of economic stimulation (economic incentives) are becoming ever more effective. The state defense order (SDO) is placed, as a rule, on a voluntary basis with the use of economic methods, which mainly serve to regulate the degree of contractor interest in fulfilling the customer’s requirements. This interest is not necessarily confined to making profit, but can also depend on additional support on the part of the customer enabling contractors to strengthen their positions in the market. (1)
As we know, the main lines of stimulating defense production and the development of the armament system are determined at Federal level. These include: advance payment for work by government customers, tax benefits, subsidies and other forms of government support, and also administrative and criminal penalties. A general legal regulatory framework is also created at Federal level. In accordance with established rules and regulations, the government customer develops its own system for providing incentives to contractors based on the organizational peculiarities of AME development, the specifics of industrial production and past experience of such work. The key concepts here are terms of payment, price and contractor’s profit.
As we go on to examine the economic methods used to stimulate SDO contractors, let us note that today, according to available data, there is no generally accepted strict list of such methods. Stimulation (incentive) is taken to mean an inducement, a spur to action, an interest in doing something. This can be achieved either by an extension of certain benefits or by threat of punishment. As regards the economic methods of stimulating SDO contractors in the broad sense of the term, these include various kinds of inducements and constraints which impel contractors to reduce (limit) the costs allocated by the customer to product cost or which result in changes in profit (increasing it when the customer’s requirements are fulfilled or surpassed and decreasing it when these requirements are not met). Such methods are closely connected with the systems of planning, financing, pricing and contract work (see Fig.). Let us examine these connections at the level of government customer activities in reference to the specifics of shipbuilding. We shall confine ourselves to methods that are implemented through the contract or immediately precede its conclusion. Tax and investment incentives lie outside the scope of authority of the government customer and we shall not dwell on them.
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Economic incentives must be based on a balance (compromise) between the interests of the customer and the contractor, and also on an organic combination of inducements (rewards) and responsibility. The procedure and extent of the use of various incentives in each particular case are determined by the specifics of the existing situation so as to enhance the efficiency of the final result (performance), which is evaluated on the cost-effectiveness criterion (when the customer has an opportunity to vary the technical specifications for the products to be supplied under the contract) or is determined as the ratio of the original contract price to the final price (when it is necessary to observe the given technical specifications). The state’s attempts to establish, in a centralized way, a detailed list of economic incentives for enterprises do not always have a positive effect, because they apply equally to different contractors irrespective of the results of their work (for example, tax benefits, terms of payment, etc.). In other words, such measures stimulate a definite area of activity instead of particular contractors. Incentives offered to contractors must be targeted and must depend on their performance results. With this aim in view, it is necessary to determine at Federal level the permissible range of incentives (with the government customer entitled to choose the most appropriate of these) and to develop a mechanism and a set of criteria for the adoption of decisions on the types and amounts of incentives to be offered to SDO contractors.
The establishment of a legislative framework for the arms development process in the conditions of a market economy is now virtually complete, although it is in need of upgrading. In the matter of economic incentives for contractors, legislation provides fairly wide opportunities. At the same time, the deficiencies in the system of regulatory and methods documents at lower levels prevent efficient use of all these incentives for stimulating SDO contractors, with the result that many of them have not yet entered the stage of practical implementation. In performing work, the SDO contractor is guided primarily by effective legislation and the requirements of the government contract. Consequently, the customer can stimulate the contractor through the contract. In my view, the most effective economic incentives are those presented in the Table.