Yet A New Twist on the Defense Production Act


DoD’s Partnership with a Development Agency to Make Loans to Address the Pandemic

The Department of Defense recently entered into a highly unusual agreement with the US International Development Finance Corporation to provide loan financing under the Defense Production Act in support of combating the COVID-19 pandemic — an outbreak which unfortunately appears out of control in large segments of the country.

This novel arrangement, backed by $100 million of federal funding, is a combination of good but overdue news (finally, a systematic use of the DPA by a reluctant administration), puzzlement over roles and responsibilities (why a development agency and DoD are tasked to expand healthcare supply chains), and, most importantly, questionable policy (why the focus on “reshoring,” the bringing home of existing industrial capability for products in short supply, rather than expanding overall capability).

First and foremost, the administration’s belatedly decision to use the DPA on more than a one-off basis against the COVID-19 outbreak is a welcome breath of fresh air. 

From the outset the administration has resisted reliance on the DPA based on an apparent mix of free market ideology, business community reluctance, and skepticism over the effectiveness of government solutions.

Plainly, however, the DPA, used together with other federal authorities and funding in a holistic manner, could help to build stockpiles, expand production and establish surge capability for critical health care supplies, including personal protective equipment. 

By its terms, the law is designed precisely for emergency situations where, as here, national security needs are not being met due to “market failures” and a bridging mechanism is needed to serve immediate needs and build capacity for the future.

Thus, this new program uses the DPA, as intended, to expand domestic production of these strategic resources and can potentially make a meaningful difference.

And, since the funding will be dispersed in the form of loans, the $100 million in federal outlays will have a multiplier effect and generate total lending somewhere in the low billions. 

We can only hope that the program it is not too little and too late given the increasingly rapid spread of the pandemic.

Unfortunately, however, even this systematic use of the DPA authority is limited in several important ways.

First, the DFC is only being allocated authority under Title III, which is designed to build and expand industrial capacity, and not Title I, which can be used to issue rated orders to build the federal stockpile and orders to allocate resources if necessary.

Second, the program unfortunately does not appear to cover the needed expansion of nationwide testing distribution (witness the long lines in Texas and elsewhere this week) — a critical shortfall that the administration insists on leaving to states with insufficient budgets.

Simply put, we need urgent federal action now on developing this capacity quickly, and if used properly. the DPA authorities together with other federal tools offer just that,

A second, and perplexing, element of the new program is why the Defense Department is partnering with a development finance agency to facilitate largely domestic health related outcomes — and why the Department of Health and Human Services (“HHS”), which has the most relevant knowledge about the health care resources needed, isn’t involved in the process.

On one level, it is sensible to engage an agency like DFC with the financial expertise and capacity to operate a “loan window” as well as some global health expertise. 

The Federal Reserve Bank, the Small Business Administration, and the Treasury effectively do the same thing when they utilize banks for their CARES Act lending programs; these agencies too lack the capability and resources to manage these programs on their own.

However, unlike these other programs, the DPA program does not involve cookie cutter loans where the lending agent simply applies a clear set of rules to determine eligibility. 

Rather, here the lender must assess the viability of health supply projects and evaluate whether projects are warranted and consistent with overall health industrial base strategy.

Thus, what remains puzzling is why DFC has been afforded a such a broad policy role here — sharing decisional authority with DoD.

Does it really make sense to have DoD, involved as a funder, and a development agency rather than HHS making priorities and deciding between competing proposals?

To be sure, there are questions about the effectiveness of HHS in ensuring a competitive supplier basis capable of meeting US needs during this and other health emergencies.

Nevertheless, HHS as a buyer, regulator, and stockpile manager in the healthcare market, is best positioned to develop a sensible long-term acquisition strategy with such industrial base considerations in mind and therefore should play a lead role in this program.

Finally, a troubling element of the new loan program is the strong focus on “reshoring” — that is, relocating to the United States existing industrial capabilities in critical industries, including PPE, medical testing supplies, vaccines, pharmaceuticals, ventilation equipment and the like.

Fundamentally, the “reshoring” focus seems to be a solution in search of a problem.

Certainly, the United States has come to rely to a considerable degree on offshore PPE, generic drugs and the like from a handful of foreign countries, including China and India.

But, while such dependence on foreign supply chains, particularly from risky suppliers, can generate vulnerability – a point China hard liners are quick to make, there is little known evidence that the actions of foreign governments are responsible for the short supply of ventilators, PPE and other pandemic needs the United States experienced.

Rather, the real problem — which reshoring doesn’t address — is the insufficient global supply to meet global demand for health product needs during the pandemic that is a 100-year event that no government has been fully prepared to address. 

Indeed, PPE from China and elsewhere has been pouring into the United States in response to enormous US demand.

In short, what we need is an expansion, not a homeward relocation, of reliable health care supply chains, including a focus on the critical elements of the lower tiers of the industrial base.

Why spend scarce federal resources on moving home existing facilities businesses in a manner that maintains the supply and demand status quo rather than adding facilities that will expand the overall supply of needed items?

Indeed, the statutory authority for the lending program, DPA Title III, is named “Expansion of Productive Capacity and Supply” — there is no mention of reshoring in the law.

A final justification for reshoring is the president’s focus on restoring “vital” US domestic manufacturing and jobs — a priority he has said that the pandemic only confirms.

The challenge, however, is how to overcome the economic reasons why some of these affected industries migrated offshore in the first place — especially labor-intensive industries that moved to lower wage rate countries.

It is questionable economic policy to try to bring back industries in a manner contrary to core principles of comparative advantage.

Otherwise, we may be forced to continuously subsidize and protect from competition uneconomic, second best industries just to have them at home — through some combination of long term funding and contracts awarded for reasons other than affordability or performance.

Moreover, while the United States should work to create a better economic environment which incentivizes US businesses to produce at home, it is another thing entirely to reward and directly subsidize businesses that consciously opted to facilitize offshore for financial gain.

Accordingly, to make sure the new program is true to the purposes of the DPA, the administration would be wise to make it a condition of any Title III loan that the funding will build new and leading US capacity that expands total global production of the particular product rather than just simply brings it home.

Jeffrey P. Bialos is a partner with the Eversheds Sutherland law firm and a former deputy under secretary of defense for industrial affairs and former member of Secure Virginia,Virginia’s homeland security board.

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