Sequestration Will Disproportionately Hurt Small, Disadvantaged Businesses

Discussions to date about sequestration have focused on major programs such as Medicare and defense spending or on large companies like Lockheed Martin, Boeing, SAIC and IBM. Lost in the noise is the potentially devastating impact on small and disadvantaged businesses. The irony is that both parties are going to hurt constituencies that they profess to support: women, minorities, veterans and entrepreneurs. Some of these groups have already experienced high unemployment due to the recession. Now they will be dealt a second blow due to sequestration.

Since 1953, it has been the policy of the federal government to encourage, assist and protect small businesses primarily by ensuring that they have an opportunity to compete for government business. Since that time, special attention has been focused on those small businesses that are owned by women, minorities and veterans. Prime contractors are encouraged or, in many instances, required to ensure that a proportion of the funds allocated to their contracts go to such small businesses.

While some of these small businesses are able to grow into large companies that no longer require government-mandated preferences, many remain small, occupying selective niches in a particular part of a single sector. This is particularly true for small businesses working for the Department of Defense. Most of them are “mom and pop” operations doing things such as building the wiring harnesses for a particular platform or weapon system, stitching together uniforms or providing back office services for a military installation.

These small businesses are particularly vulnerable to perturbation in defense spending. Unlike the large defense companies, many small businesses are often one order away from going under. Small business owners can have difficulty establishing lines of credit and have to rely heavily on home mortgages to finance their businesses. They rarely have access to alternative markets if their primary customer goes away. Having acquired material, tools and workers based on an expected level of business, they will have great difficulty covering their costs if their customers decide to buy less. They are the least able to absorb a 9-10 percent cut to their business caused by sequestration.

Tomorrow the House of Representative’s Committee on Small Businesses will hold a hearing on the threat sequestration poses to small businesses, jobs and the economy. This is a good step but it comes late in the process.

Of course, sequestration will also impact medium and large businesses. It will be particularly problematic in the defense sector where a large number of major defense programs could be forced to renegotiate contracts. The Air Force has already warned that it may have to cancel its current fixed price contract with Boeing for the KC-46 tanker in the event of sequestration. We can expect a blizzard of Nunn-McCurdy breaches even on well-run programs as sequestration forces the Pentagon to reduce the quantity of platforms and systems it can buy forcing unit prices to skyrocket. Ironically, if this phenomenon proves to be widespread it will undermine sequestration’s goal of reducing government expenditures by forcing the Pentagon to pay more in the future for the things it buys.