With $36.4 billion in funding, Defence is heading towards 2% of GDP

Against that strategic background, the 2018–19 defence budget continues to deliver the vision set out in the White Paper. In 2018–19, the government is increasing the defence budget towards its commitment of 2% of GDP by 2020–21. Based on the Defence Portfolio Budget Statements (PBS) and GDP predictions in the budget papers, we calculate that it will fall just short, at 1.98%, but that’s essentially a $400-million rounding error. And, based on forward estimates predictions, the Defence budget will grow past 2% in 2021–22.

We should note, however, that Defence’s funding, as presented in this year’s budget, falls short of the fixed funding line presented in the White Paper by around $5 billion by the end of the forward estimates. The government essentially made two funding commitments—2% of GDP and a fixed funding line—and it’s possible it could meet one without reaching the other. Nonetheless, Defence continues to enjoy real increases to its funding.

The growth continues to be centred on Defence’s capital program. While capital investment has historically been the poor cousin alongside personnel and operating funding, the three are now roughly equivalent, and by 2020–21 capital funding could exceed the others for the first time. But it will need to, if Defence is to be able to afford the future force.

Defence has used that increase to invest heavily in remediating infrastructure. And while the shipbuilding enterprise is still in its early days, many other capital investment projects are delivering capability—Air Warfare Destroyers, P-8 maritime patrol aircraft, trucks, battlefield communications and airlifters, for example. And the Air Force’s transformation into a fifth-generation force is well underway. There is no doubt we are getting a more capable ADF.

We are starting to see the first signs of cost pressure on Defence

But, as always, there are things to be concerned about.

Full-time ADF personnel numbers are programmed to grow to 59,794 this year on the way to the White Paper target of 62,000. But actual growth has been slow, and Navy (potentially the service whose future platform growth is greatest) is going backwards. Civilian numbers fall by around 2,000 due to the Australian Signals Directorate becoming a statutory agency. Overall, however, net civilian numbers remain unchanged at the White Paper level—that is, well below where they were five years ago, potentially requiring greater reliance on expensive contractors. Funding for personnel effectively flat lines at less than 1% real increase annually over the forward estimates. That seems to be inviting future cost pressures, since ADF numbers are meant to increase, and individual personnel costs have historically increased in real terms.

Also, sustainment budgets appear to be increasing faster than predicted. Between last year’s PBS and the mid-year Additional Estimates update, the sustainment budget increased by $1.5 billion, or 16.7%. And this year’s sustainment budget is around $1 billion more than predicted last year. Some of that is likely to be due to different accounting practices that Defence has adopted, but one gets the sense that perhaps the sustainment requirements of an increasingly complex force were underestimated in the White Paper and Defence is having to adjust.

That could be one reason why Defence is underachieving against its predicted capital spend. Overall, its capital spending is increasing at a healthy rate, but it is likely to fall short of the spend predicted over the 2016–17 forward estimates by about $4 billion or so. Half of that may be due to foreign exchange adjustments, so it’s not a huge shortfall in the grand scheme of things, but probably confirms, first, that it’s always hard to ramp up investment spending quickly and, second, the sustainment increase had to come from somewhere.

Investment in ICT appears to have crashed last year, falling by 72% or $644 million between the PBS and Additional Estimates. It may be that ICT projects failed to deliver, or that sustaining current legacy ICT systems sucked funds away from investment in new acquisitions. Since there’s a complete lack of public reporting on the ICT program, it’s impossible to know what happened. The lack of transparency on ICT is particularly troubling, as the Integrated Investment Program foreshadows over $10 billion in ICT projects that are central not only to Defence’s corporate information systems, but also to its war-fighting ability.

This lack of transparency extends beyond the ICT program. While the government is claiming to be approving record numbers of projects, there’s no public record of what they are, let alone information on their scope, schedule or budget. For approved projects, there’s no reporting on progress unless they’re big enough to make the Major projects report of the Australian National Audit Office (ANAO). This year, for the first time, the PBS does not even include a list of project approvals planned for the coming year. That’s unfortunate, because capital investment projects lie at the heart of the government’s White Paper plan, so both the government and Defence should do better at transparency.

Everybody has a view on industry policy but the key question must always be, does it make sense to do it here?

The Cost of Defence looks at two issues in more detail this year. The first is the government’s defence industry policy. A few years ago, it seemed as if everybody had an opinion on which fighter planes and submarines Australia should buy. Now the discussion has moved on to whether and what we should build in Australia. At some level, this isn’t a debate that can be resolved by data alone, as it involves issues of identity and ideology. At one end of the spectrum there are the economic rationalists who argue that there’s no net national benefit in subsidising uncompetitive industries, whether they be car manufacturing or shipbuilding. While Australia has been the world’s fifth biggest arms importer over the past decade, that has enabled us to get access to the most advanced military technologies when we need them at a price we can generally afford.

At the other end there are those who argue, whether for reasons of sovereignty, jobs, or even parochialism and prestige, that we should do as much as we can here. And in between there are those who see merit in both sides; perhaps we should be doing more to keep some of the money that we send offshore to buy arms here in Australia, but not at the 30-40% premium RAND Corporation suggested we were paying for shipbuilding, particularly if it means less capability for our servicemen and women.

The government’s industry policy includes elements of all of the above, which means that at times it appears inconsistent. Its policy documents state that, ultimately, developing Australian industry and exports is about improved capability for the ADF. Yet in practice it appears to favour building in Australia regardless of the cost premium and consequent decrease in output delivered to the ADF. Ultimately, our view is that we should support Australian defence industry when the costs and risks are understood and it makes sense to do so. However, based on the ANAO’s analysis, it doesn’t appear that Defence understands the premiums involved in local builds, so it’s hard to see how robust the business cases for local builds can be.

That said, once the government has made the initial decision to build in Australia, its choice of submarines, offshore patrol vessels, and armoured vehicles appears to have been based primarily on capability. For their part, the international primes have got the message that to be competitive they need robust Australian industry plans and partnerships with local companies and universities. Centres of excellence and cooperative research undertakings have been established, so industry seems to be meeting the government’s demand it put more skin in the game.

Increasing funding for innovation and R&D seems like a safe bet

The innovation programs announced in the White Paper appear to be getting grant money out the door and, while it’s early days, anecdotally at least we are seeing local success stories. Since the funding involved is small compared to that spent on things like shipbuilding, it makes sense to double or even triple it in order to support the government’s broader innovation agenda, to keep up with other nations’ investments in emergent technologies, and to enhance Defence’s existing capabilities, which will have to remain in service for a long time until the future force is delivered.

In terms of exports, the goal of becoming a Top 10 defence exporter seems not only overly ambitious but also distracting. Rather than focusing on exporting platforms, there’s probably more benefit to be had by leveraging our involvement in the shipbuilding and armoured vehicle projects into greater access for Australian industry into the international primes’ supply chains for projects that they’re conducting around the world, not just here. That can achieve economic benefits here long before the mirage of submarine exports is realised.

Naval Shipbuilding locks in $3.5-4 billion of cash flow, every year, forever

Which brings us to the second area that we’ve examined in more detail: the affordability of the Naval Shipbuilding Plan. There’s no getting around the fact that building modern warships is expensive. There are two numbers that perhaps warrant closer consideration than the $89 billion headline figure that’s widely quoted. The first is the $20 billion that the future frigate and future submarine projects will have spent between them before they each deliver usable capability (probably around 2028 and 2032, respectively). That’s a lot of cash to have tied up while our strategic circumstances deteriorate and our current platforms age. As ASPI has suggested previously, it’s probably worth looking at what Defence can do in the meantime in the form of cost-effective ways to enhance capability sooner.

The second number is the $3.5–4 billion in annual cash flow that we estimate the shipbuilding plan will require once it’s up and running. Granted, the capital equipment budget is growing. But shipbuilding will potentially consume around 30% of it on an ongoing basis. On the one hand, this smooths out the peaks and troughs, but on the other, since it sits at that level forever, it limits the room available for other capabilities. And since continuous local build appears to now be the government’s policy, there are likely to be other builds locked in forever (protected vehicles, armoured vehicles and so on), further shrinking the funding space for other capabilities and future flexibility.

Since the Navy is essentially undergoing a transformation that will double its tonnage, sustainment costs will also increase. Submarine and frigate sustainment (currently the largest and third largest sustainment lines in Defence) are likely to triple and double, respectively. Submarines alone could cost $2 billion a year to operate, on top of $2 billion a year to build, which together will potentially require 10% of Defence’s total budget for one capability. Granted, we are still a long way away from having all the future frigates and submarines, but at a time when western navies are shrinking due to the cost of building and operating modern warships, the fact that we are moving in the other direction raises questions about affordability.

And in order to get something close to a reasonable return on that capital investment, the Naval Shipbuilding Plan locks in a two-year delivery ‘drumbeat’ for frigates and submarines. Not only does this mean that it will be a very long time before the future fleet is delivered while our strategic environment is deteriorating, but it also limits Defence’s ability to manage cash flow by slowing things down, as that will further delay delivery and affect jobs.

There are other cost pressures. The future sustainment cost of the Joint Strike Fighter is a big unknown, but if it’s anywhere close to the jump from the classic Hornet to Super Hornet (around three times as much per aircraft), it will be hard to absorb.

In short, the megaprojects, in particular shipbuilding, have the potential to crowd out other capabilities. Historically, it’s the enablers (facilities and ICT) holding everything together that suffer. But it could be that the big projects will also distort the overall force structure. There are already signs of that, and the ANAO has noted that Defence may have to increase the future submarine project’s budget by $6.7 billion, even before the first submarine is delivered. That can only come from other areas of planned expenditure, most likely other capital investment.

Because these things are so big, and so important, Defence needs to get better at sharing information with the public

In the light of their centrality, both to Australia’s future military capability and to the government’s defence industry policy, there need be informed understanding and public scrutiny of the future frigate and future submarine projects—the two biggest projects in Defence’s, and potentially the nation’s, history. That discussion must be supported by real data. As a minimum, the two projects should be included in the ANAO’s Major projects report, regardless of whether they have received formal second-pass approval from government.

Because the media, the public and Defence often argue past each other when discussing the cost of military equipment, we have include a chapter (Chapter 7) that illustrates how Defence costs major acquisitions and shows why the ‘sticker’ price is very different from Defence’s total project budget. Hopefully this will contribute to better discussion around what the cost of Defence and its capabilities actually is.

So to sum up, the government is broadly meeting its commitment to get the Defence budget to 2% of GDP. But the content and timing of Defence White Paper’s investment program have not been revisited, despite changes (for the worse) in the strategic environment it was intended to address. Funding pressures are already emerging, with more to come in sustainment and personnel right at the time when a large share of the investment budget is being tied up in shipbuilding.

Informed decision making and public debate on these issues is essential to navigating them in order to keep Australia secure. To support this, the government needs to demand Defence provide greater public transparency in its planning and reporting.

The full report is available here.