Defense industry doesn’t spill over to economic growth.

Conventional arms transfers can have separate, microeconomic effects of interest to a discussion of economic security, including effects on innovation and manufacturing highlighted in the Presidential Memorandum. The defense industry is not like a normal commercial industry, where corporations use retained earnings from their past sales—or borrowing from investors, who expect to be repaid from future sales revenue—to invest in research and development. Innovation in the defense industry is mostly supported by direct government research and development (R&D) contracts. That is, the DOD customer directs the trajectory of innovation and pays for specific R&D effort. Another fraction of total defense R&D comes from companies’ Independent Research and Development (IR&D) expenditures, reimbursed by the government as part of the overhead cost of other government-funded defense projects. IR&D spending is company directed, but it is also paid for by the DOD customer, not drawn from the company’s retained earnings. As a result, general increases in defense firms’ profitability—which might stem from arms sales approved under the CAT policy—do not generally have much effect on defense innovation at the systems level. However, many suppliers in the defense supply chain operate on commercial terms, and for them, the general added revenues from expanded defense sales contribute to the retained earnings that support their R&D investment. Thus, at the supplier level, arms sales can contribute to US innovation. However, generally, the suppliers are less visible, as are the innovations they might choose to invest in with the marginal dollar of income. Due to that lack of visibility, it would be difficult for an economic assessment, as part of the CAT approval process, to give much weight to the potential innovation-related investments by commercial firms at lower tiers of the defense supply chain