This section examines the risks and challenges to the government’s promise of spending 2% of GDP on defence by 2023-24 from both the supply (the government) and demand
(Defence) sides.
The most pressing risk to defence funding over the next few years comes from the
government’s commitment to return the federal budget to surplus. The relatively generous near-term treatment of defence funding in the last two budgets (don’t forget the previous government provided around $3 billion extra in near-term funding last year) owes much to the deficit being so large as to preclude a near-term return to surplus. Had a surplus been within reach, the story would likely have been very different. Past experience with the recessions of the early 80s and 90s confirms that Defence can’t count on being spared when the time comes. If any proof is needed, the cuts in anticipation of ‘the surplus that never was’ in 2012-13 should settle the matter (see Figure 3.3).
In fairness, it should be recognised that the current government showed an uncommon degree of resolve in the 2014 Budget by boosting near-term defence spending at the same time as imposing unpopular spending cuts and tax increases on other sectors. Perhaps it’ll have the resolve to maintain its commitment to defence spending concurrent with the steps necessary to deliver a surplus. I suspect that it’ll be a question of timing. Delaying a surplus
0 5 10 15 20 25 30 35 40 45 bi lli on 2 01 4- 15 $ Operational supplementation
Baseline costs 5.3% real growth p.a.
actual spending budget estimates projected 1. 74 % 1. 77% 1. 75% 1. 78% 1. 74% 1. 94% 1. 82% 1. 70% 1. 76% 1. 76% 1. 76% 1. 79% 1. 92% 1. 88% 1. 85% 1. 80% 1. 75% 1. 70% 1. 78% 1. 80% 1. 71% 1. 60% G DP s ha re = 2. 00% 1. 96% 6.1% real growth
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by one year to preserve defence spending might be possible in the first year of a government’s term, but it’s unlikely to happen in the third year with an election in the offing.
On current fiscal projections, the federal balance will be close to surplus around 2017-18 or 2018-19. On the standard electoral cycle, that corresponds to the first or second year of the next term of government and the start of the projected ramp-up to 2% of GDP. There’s little point going into the myriad permutations of economic and electoral possibilities. Suffice to say that even though the government has so far demonstrated a strong commitment to defence, it has also shown a willingness to break promises (or more politely, to reframe commitment) in pursuit of so-called ‘budget repair’. Thus, we have no assurance that medium-term defence funding will be immune from cuts if that’s what it takes to get into surplus. Nor is that necessarily undesirable, if the gains from a (somewhat) speedier return to surplus outweigh the losses from a (somewhat) slower increase in defence spending. On the demand side, it’s useful to separately examine defence spending in the short to medium term (1 to 3 years) and the long term (4 to 10 years). In the short to medium term, the planned rapid growth in capital investment over the next two years introduces the risk that money will be handed back—especially given the planned rapid surge in capital investment over the next several years. However, and as explained in Chapter 8, the presence of several large off-the-shelf purchases gives cause for a degree of optimism. Anyway, the risk of money being handed back isn’t a good reason to scale back plans at this stage. Given the disruption and delay to the investment program in recent years (see Figure 3.3) it’s more than worth the risk to regain the momentum towards re-equipping the ADF. In the longer term, the question is whether Defence (and defence industry) can absorb the six years of budget growth necessary to achieve 2% of GDP by 2023-24. In terms of raw spending, there’s no reason why they couldn’t. As Figure 3.5 shows, we have 3-4 years to plan and prepare for a ramp-up requiring 5.3% real growth each year. It would be learned helplessness in the extreme to throw up our hands and say we can’t manage a boost in defence spending from 1.75% of GDP in 2017-18 to 2% of GDP in 2023-24. After all, we managed to mobilise, fight and win WWII in a shorter period of time.
Looking beyond the question of raw spending, things get more interesting. Figure 3.6 shows the budgeted (2014-15 to 2017-18) and projected (2018-19 to 2023-14) shares of the defence budget going to personnel, capital investment and operating costs. For the period beyond 2017-18, personnel and operating costs have been projected out as explained below, while capital investment is estimated as the simple residual (= budget – personnel costs –operating costs). This makes sense because personnel and operating costs are effectively a consequence of the size and shape of the ADF, whereas the level of capital investment is discretionary on a year-to-year basis.
Consistent with established per-capita trends in personnel expenses (see Chapter 2 of this Brief) and given that current plans have the ADF reaching its 59,600 end state in 2017-18, personnel costs have been assumed to grow at 2.4% p.a. real beyond the Forward Estimates. Similarly, operating costs are assumed to grow at 3.0% p.a. real over the same period
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Figure 3.6: Budgeted, estimated and projected costs 2014-15 to 2023-24
Source: 2014-15 PBS and ASPI analysis
The resulting rapid growth in capital investment is extraordinary. If achieved, it would mean that capital investment over the next decade would amount to $112 billion compared with a mere $66 billion over the preceding decade measured in 2014-15 dollars. What about the years beyond 2023-24? Presumably the government doesn’t plan to increase defence spending to 2% of GDP and then let it fall? Figure 3.7 plots the historical and projected share of the defence budget out to 2033-34 assuming that the labour component of the ADF remains static post 2017-18.
Figure 3.7: A mountain of equipment
Source: DAR, 2013-14 PAES, 2014-15 PBS and ASPI analysis 6 8 10 12 14 16 18 bi lli on 2 01 4- 15 $ (b ill io n) personnel capital operating Operating Costs 3.0% real growth 2016-17 to 2023-24 Personnel Costs 2.4% real growth 2017-18 to 2023-24 Capital Investment 10% real growth 2016-17 to 2023-24 Budget and Forward Esimates 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% pe r c ent ca pi ta l Projected Budgeted Actual Historical Average Financial Crisis Impact 2% of GDP target date
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Beyond 2023-24, the capital component of the budget goes into slow decline as growth in personnel and operating costs outpaces GDP growth. Nevertheless, the subsequent decade would see an eye watering further $183 billion in 2014-15 dollars go to capital investment (assuming long-term real GDP growth of 2.5%). Given that we’ve managed to recapitalise a good share of the ADF during the fifteen years immediately past, it’s pretty clear that such high levels of capital investment are unnecessary for a defence force of the size presently planned.
One way to make sense of the situation outlined above would be if there was a plan to expand the size of the defence force. By doing so, personnel and operating costs would rise and less money would be left for capital investment. In theory at least, there exists a larger ADF for which 2% of GDP in 2023-24 and beyond would bring personnel, operating and investment spending into something like a sustainable balance. (In practice, there’ll never be a ‘steady state’ apportionment of capital, personnel and operating costs because they each have slightly different intrinsic growth rates).
However, to date, the government hasn’t discussed any plans for expanding the size of the force. To the contrary, it has been hedging previous promises—most especially regarding 12 submarines—and more generally expressing concern about the parlous state of the DCP. At least in its public disclosures, the government has been worrying about Defence having too little money rather than too much. It may be that the government is not yet aware of the full consequences of its 2% promise—it’s only early days in the white paper process.
The situation shouldn’t come as a surprise. The promise of raising defence spending to 2% of GDP within ten years wasn’t the result of detailed financial analysis. Rather, it was an
artefact of our decimal counting system (hence the decade) and the unofficial NATO benchmark of 2% of GDP. A benchmark that is much more often honoured in the breach than in observance—in 2013 only three of 25 European NATO countries reached that level. More importantly, the promise of 2% in a decade was a signal to the electorate, and to Australia’s allies, of the soon to be government’s commitment to Australia’s defence. It would have been an extraordinary coincidence if spending 2% of GDP in 2023-24 and beyond was consistent with an ADF of the size and shape currently planned. It was always overwhelmingly likely there would be either too little or too much money.
We do not know how Defence assesses the situation. The publicly released version of the Incoming Government Brief redacted every single word of their advice on the matter. Perhaps it doesn’t believe it’s going to happen, but it’s happy to get what it can in the meantime. As noted in Chapter 2, Defence already quietly increased the target size of the ADF from 59,000 to 59,600 in the transition from the Gillard to Abbott government. So how much larger would the ADF need to be in order to re-establish a credible balance between capital, personnel and operating costs in 2023-24? If capital investment as a share of the budget was limited to its 16-year average (2002-03 to 2017-18) of 26.3%, and the ratio of operating costs to personnel costs is assumed to remain at its 2023-24 level (0.98), and if all of the additional personnel are uniformed, the ADF would have a strength of 75,200 personnel, fully 15,600 higher than today. Alternatively, if we assume that the ADF is becoming more capital intensive and the investment share rises to 30%, the size of the ADF
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would need to be 70,700 in 2023-24 or 11,100 more than presently planned. Given trends in equipment costs and the several looming mega projects on the horizon (submarines and frigates), the latter is probably a better estimate.
No doubt the situation will become obvious in the development of the 2015 Defence White Paper. When it does, we should expect to see two things. First, the size of the force will grow. An extra battalion or two to crew the new LHD amphibious vessels would help bring things into balance, as would a squadron of jump jet variants of the F-35 to reinstate the fleet air arm aboard the LHD. Such possibilities aren’t to be discounted. Back in 2008 Andrew Davies and I modelled the sorts of defence forces we could have if we spent around 2% of
GDP in the 2020s (see the ASPI paper Strategic Choices: Defending Australia in the 21st
Century) and we were surprised by just how much capability could be afforded.
Second, with so much money available, we should expect to see proposals of diminishing marginal worth brought forward (see preceding paragraph for examples). Even if
prioritisation is done properly, every new initiative enabled by extra funding will be of less value than existing ones. But 2% of GDP will enable some especially marginal propositions to be seriously considered. The most recent candidate is the proposal to retire the Anzac class frigates early so as to allow the AWD programme to roll on into building their replacements. By so greatly loosening the fiscal disciplines on Defence, the challenge for the government will be to contain the potential for far-reaching waste.
So what’s the bottom line? I’ll resist the temptation to reiterate, yet again, the argument for why the GDP share is a poor basis for deciding upon defence spending. I’m tired of making the argument and I expect others are tired of hearing it. Instead, let me observe that we’re firmly into the ‘tail wagging the dog territory’ wherein an arbitrary number is set to unleash a previously unplanned expansion of the ADF at enormous cost and absent a consideration of what it will add to Australia’s security beyond sending a message to allies and friends.
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Chapter 4 –Defence Reform
The new government brought with it a renewed focus on defence reform. With the dust only just settled on the 2009 Strategic Reform Program (SRP), it must seem a bit like groundhog day at Defence. But until the government and public have confidence that Defence is efficient, the cycle of reviews, reports and reform will continue.
Central to the emerging reform agenda is the government’s commitment to an independent ‘first principles’ review of how Defence is structured and operates. At the same time, the National Commission of Audit has made substantial recommendations in a number of areas.
This chapter sets the scene for what’s likely to come. There are five sections. The first surveys defence reform over the past 35 years. The second summarises the SRP. The third explores post-SRP reform in Defence. The fourth examines the National Commission of Audit. The fifth opines on the challenges and opportunities for the future.
Much of the material in this chapter is taken from (1) a presentation by the author to an Atlantic Council workshop on comparative defence reform held in Ottawa in June 2013 and (2) the ASPI submission to the National Commission of Audit from November 2013. Both documents can be accessed in full at the ASPI website. For even more detail, see previous
editions of the Budget Brief and Ergas (Agenda, Volume 19, #1, 2012) and Ergas and
Thomson (Agenda, Volume 18, #3, 2011).
Consistent with the financial focus of the Budget Brief, the emphasis in what follows is on efficiency rather than on behavioural or cultural reforms.