Fiscal pressures coupled with new strategic realities will require a reorganisation of the force that enjoyed massive budgets in the years after the attacks September 11, 2001, the US defence secretary said.
"Coming out of more than a decade of war and budget growth, there is a clear opportunity and need to reform and reshape our entire defence enterprise," Hagel said in a speech at the Centre for International and Strategic Studies (CSIS) think tank.
Budget reductions mandated by Congress will require a smaller but well-armed force that will have to sacrifice a degree of combat readiness, he said.
"In some cases we will make a shift, for example, by prioritising a smaller, modern and capable military over a larger force with older equipment," Hagel said.
His comments coincide with a review of military priorities now underway, with senior officials and commanders weighing a potential downsizing of the Army from more than 500,000 to 420,000 troops.
To preserve the military's edge, the Pentagon also would have to tackle ballooning personnel costs that threaten to swallow up funds for new weapons, he said.
Without scaling back pay and benefits, which make up about half the defence budget, "we risk becoming an unbalanced force," Hagel said.
"One that is well-compensated, but poorly trained and equipped, with limited readiness and capability."
As the country moves away from a "permanent" state of war, military strength would remain important but play a supporting role to diplomacy, he said.
The United States "will need to place more of an emphasis on our civilian instruments of power," Hagel said.
The military will "remain an essential tool of American power and foreign policy, but one that must be used wisely, precisely, and judiciously," said the former Republican senator, who was an outspoken critic of the Iraq war.
While Washington needed to guard against an arrogant stance in its foreign policy, Hagel also expressed concern that Americans are growing "skeptical about our country's foreign engagements and responsibilities."
He said that "only looking inward is just as deadly a trap as hubris, and we must avoid both in pursuing a successful foreign policy in the 21st century.
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