By Harry Richer
Monday, November 02, 2026
Congress left session last month with a list of
unfinished bills as members headed out for the midterm elections. Among them is
the massive $1.15 trillion National Defense Authorization Act (NDAA), H.R. 8800, which authorizes defense spending for fiscal
year 2027. The Senate has yet to move the bill to the floor, but both parties agree that
passing an NDAA is critical.
News out of Iran, for example, continues to show aging
ships, depleted stockpiles, and overstretched theaters of war. The U.S. needs to rebuild its munitions stockpiles, and it needs to
do so quickly, but the response from Washington has been to continue to push
for greater state involvement in the defense industry. Senators from across the aisle have proposed further restrictions on
contractors’ stock buybacks, dividends, and executive pay. At the same time, we
have seen the Trump administration order plans for a fifth public naval shipyard.
The answer may not be as simple as throwing more and more
government spending at the problem. The American economic marketplace is
competitive, and it should be the place where private companies strive to build
what the country needs. The country’s munitions shortages are not only the
result of the war in Iran, after all—they are the predictable result of
procurement decisions that for decades have undermined the market signals that
form the basis of any healthy industry. Small and irregular orders have meant
that suppliers have been discouraged from building new factories or investing
in new machinery as they cannot be confident that future sales will cover the
investment; sole-source contracts—meaning contracts that the government awards
to individual companies without a competitive bidding process—have eliminated
the market competitiveness that drives innovation. The Pentagon has also had a
historical preference for “cost-plus” contracting where the payout to a defense
firm is directly tied to that firm’s costs. This reduces the incentives for
firms to innovate, increase efficiency, or improve on initial offerings.
Defense is not an ordinary consumer market; civilians
aren’t buying Patriot missiles. Suppliers inevitably depend heavily on
procurement decisions, but government procurement does not mean abandoning
market incentives. Competition should be encouraged for its contracts, with
bidding made accessible to new suppliers, and efficient delivery and innovation
rewarded. Precisely because it is the dominant customer, Washington must become
a better customer. Getting market incentives right becomes even more important,
not less, in a market like this.
Government-led private equity stakes have further
distorted natural market movement. Through the Department of Commerce,
Department of Defense, Department of Energy, and the U.S. International
Development Finance Corporation, the Trump administration has taken around $27
billion of ownership stakes in more than 30
companies. In January, for example, the government took a $1 billion stake in L3Harris Technologies’ missile
business, which will compete for Pentagon contracts. The proposed Senate bill
would give further leeway to the Office of Strategic Capital to buy equity positions. The
state is fast becoming a customer, regulator, and owner all at once. The
government must decide whether it is an umpire or player when it comes to
defense—it cannot be everything, everywhere, all at once. Other countries that
have tried to be everything to the defense sector, such as South Africa through
its state-owned aerospace and defense conglomerate Denel and Australia in its Collins-class submarine program, have often floundered.
The Trump administration and many of its supporters like
to preach the virtues of free enterprise and the free market, arguing that
businesses flourish when the state gets out of the way. Yet, on the subject of
defense production, they seem to believe those principles no longer apply. By
abandoning those principles, the U.S. is kneecapping its own defense sector’s
ability to meet the country’s defense needs. As Colin Grabow has written for the Cato Institute, “The best way to help US
manufacturers and strengthen the US defense industrial base is usually the
liberalization of trade barriers and the removal of government interference in
market processes, rather than just more tariffs, localization mandates, and
subsidies.”
Washington has already moved beyond purchasing weapons to
financing selected contractors directly, as shown by the Pentagon’s $1 billion
investment in L3Harris’ missile program. When the state begins to pick winners
and losers in an industry, innovation disappears as companies compete to figure
out not how to best innovate and improve, but how to become a state winner. As
a result, efforts that would have gone toward out-innovating one’s competition
instead go toward lobbying the state.
When Congress returns in November, negotiators for the
NDAA will be deciding how much control Washington will exercise over the
defense industry. This is not just about how many missiles the Pentagon
orders—President Donald Trump has already directed officials to restrict buybacks and
dividends with defense contractors and interfere with executive pay. Replacing
commercial judgment with political priorities limits the ability and
flexibility of both firms and shareholders to invest and innovate. Restrictions
on shareholder payouts and executive pay do have precedent in taxpayer bailouts
and banking regulation, but selling equipment to the government should not mean
that the state takes over decisions that are usually reserved for company
boards. Unlike bailed-out firms in the banking sector, these companies do not
require emergency assistance, nor can they bring down the American economy
through irresponsible behavior. Washington should enforce contracts and
penalize failure, not add additional restrictions above what you would expect
for any industrial sector.
Going even further, the Senate’s version of the NDAA
forces contractors to forgo shareholder payouts unless they have investment
plans approved by the Pentagon. When the Pentagon decides whether a business’s
investment plan is acceptable, it dilutes the power of the market to transmit
knowledge. Knowledge—which is tacit, interpersonal, and dispersed—is
transmitted most effectively through price signals in the market, and a central
planner, whether in the Pentagon or in a socialist government, simply cannot possess
the knowledge to know if a business’s investment plan will meet the needs of
the country in five or 10 years. Many in the defense industry will question why
this is even included in the NDAA. What is the government trying to achieve?
The answer can only be greater power to control and direct the defense sector.
Senators believe that the state can plan the future of these companies better
than the firms themselves. This is rarely a recipe for success.
Another problem with the current procurement system is
that it makes it difficult for startups, which add vitality and innovation to
the industry, to get a foothold. Defense manufacturing and research have long
been dominated by legacy defense companies like Raytheon or Lockheed Martin;
the institutional knowledge of these contractors should not be discounted.
Developing a new missile-defense system or a nuclear submarine requires the
kinds of intense and deep pools of capital, alongside expensive and often
long-term research and development programs, that, often, only larger companies
can provide. However, when high compliance costs and lengthy qualification
processes let a small number of legacy firms dominate procurement, new entrants
to the market are shut out before they have the chance to prove their
technology. Legacy programs can be sustained through legacy companies, but
these companies are often less capable of finding the innovations that the
quickly changing nature of modern warfare demands.
Take, for example, defense startup Hadrian, which has,
using AI and advanced robotics, built four accelerated-production factories to
manufacture precision components for both naval and aerospace systems. These
include parts used in advanced munitions, submarines, and aircraft. The
company’s use of AI in its precision manufacturing platform has cut the time
needed to train its human operators to as little as 30 days, down from the
years-long apprenticeship models that have long dominated the sector.
Hadrian’s “Factory of the Future” in Alabama won a $900 million contract from the Navy earlier this year, and
the company has also established a partnership with Lockheed Martin,
demonstrating how established defense contractors are increasingly looking to
innovative manufacturers to strengthen their own production capacities. Yet,
believing that its automated manufacturing model could help relieve bottlenecks
in American defense production, private investors were looking to Hadrian as a
solution for America’s military needs well before Congress did. The company
raised $1.5 billion of private capital before the Navy’s contract
arrived—evidence that the free market is capable of understanding the country’s
defense industrial needs independent of government direction. The trend is
similar for companies like Castelion and Shield AI, which are now both valued at
around $13 billion. Castelion has attracted significant private investment as
it pursues low-cost, short-production hypersonic weapons, and Shield AI has
developed autonomous piloting software that costs less and runs faster than the
slow-moving bespoke programs that have long dominated the area.
Private capital does not need the government to take
equity stakes in companies, nor does it need subsidized production through the
Defense Production Act. Government action can play a helpful role in defense
production, but noncompetitive procurement cannot creatively produce cheaper
products or inspire innovation. By widening procurement to include new, young
startup competitors rather than relying on established companies, streamlining
licensing and supplier qualifications, and committing to predictable multiyear
orders, Washington could help unlock greater private investment into the
defense industry. Washington’s task should not be to dictate to the defense
sector how it should operate, but to create the conditions that allow for
defense companies to compete, innovate, and expand.
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