Tag Archive for: defence budget

Budget: 10-year defence spending up 11 percent from 2022 plan

/in

The Australian federal budget shows defence will receive a significant increase in funding over the next decade under the new National Defence Strategy and Integrated Investment Plan.

The budget papers, issued on 14 May, include a chart comparing the proposed funding with the spending profile projected ahead of the 2022 election, when the AUKUS deal had been struck but no additional resources arranged.

It shows that defence is now due to receive a total of $718 billion over the 10 years to 2032–33, up 11 percent from the $647 billion envisaged in the 2022 Pre-Election Fiscal Outlook, a politically independent document prepared by the Treasury.

The increase in funding starts slowly but gets larger over the decade, so that by 2032–33, defence is projected to have $96.5 billion to spend, which is a massive 17.1 percent more than was provided for the same year in 2022.

Last year’s budget, which was handed down shortly after the Defence Strategic Review called for a sweeping overhaul of Australia’s military capabilities, was criticised for providing no additional funding over the four-year budget period, other than compensation for a fall in the value of the Australian dollar. With no compensation for inflation, which was then running at 6 percent, defence was falling behind.

The only increase last year came beyond the four-year budget period, with a provision for an additional $30 billion from 2027–28 and beyond. With the passage of 12 months, the first of that spending is now within the budget horizon. The budget provides $67.4 billion for defence in 2027-28, a 10.6 percent jump from 2026–27.

The budget also incorporates an additional $1.7 billion for shipbuilding over the four-year budget period, which is part of the government’s $11.1 billion response to a review of the navy’s surface fleet, announced in February.

The cost of implementing the National Defence Strategy and its associated spending plan, the Integrated Investment Program, over the budget period is an additional $5.7 billion, rising to $50.3 billion over the decade.

Over the next 10 years, defence spending will average an annual increase of 6.6 percent, delivering a real increase ahead of inflation. Treasury predicts consumer-price inflation will fall to 2.75 per cent this year and next, and then average 2.5 percent beyond that.

The government faces a series of other spending pressures, with the cost of the National Disability Insurance Scheme forecast to keep rising at an average 9.2 percent a year over the decade and absorbing more than defence. Interest costs are predicted to rise by an annual average of 9.9 percent over the decade, while aged care, hospitals and Medicare all face costs rising at average rates of between 5.7 and 6.5 percent.

Over the next four years, the defence share of the federal budget will rise only marginally from 6.1 to 6.2 percent. However, other arms of government are receiving smaller shares. Education’s share of the budget will fall from 7.1 per cent to 6.8 per cent, while the health share drops from 15.5 percent to 14.8 percent.

As indicated with the release of the National Defence Strategy and Integrated Investment Plan last month, the increase in government funding goes only part of the way to covering the cost of the major planned investments.

The $50.3 billion in additional budget funding over the decade hardly covers the cost of the submarines, which the investment plan said would be greater than $50 billion over the decade.

The budget funding will have to be supplemented by a further $73 billion in cuts to existing programs to fund the $330 billion total investment in new equipment over the decade.

Cuts include the reduction in the number of infantry fighting vehicles and cancelling the purchases of a fourth squadron of F-35A fighters and two joint support ships, however a full list has not been published. The cuts are likely to include many minor deferrals and reductions in the scope of purchases, however $73 billion is a lot to take out of the existing investment program.

Total defence spending is now expected to rise to 2.3 percent of GDP by 2033–34, up from 2.1 percent this year. The government had flagged that spending would reach 2.4 percent, however an upgrade in Treasury’s forecast for nominal GDP means that the percentage will now be slightly less.

There has been little change in the Australian dollar’s exchange rate since the mid-year budget update last December so the budget does not include any of the compensation that inflated last year’s defence resourcing. The Australian dollar did fall over the latter half of 2023, which meant there was an additional $2.5 billion provided by the Finance Department to offset the additional cost of equipment purchased abroad, however this was included in the 2023–24 additional estimate statement.

National Defence Strategy: too slow on air-and-missile defence

/in

Australia’s failure to prioritise acquisition of surface-to-air systems for missile defence is alarming.

We need such equipment as part of our measures for facing one of our most demanding threats—China’s large inventory of conventional and nuclear long-range strike missiles.

Those Chinese weapons could hit airfields, other bases, ships and civilian infrastructure, debilitating our ability to fight.

Three main means of countering long-range strike weapons are available: passive measures such as hardening or dispersing their targets; intercepting the incoming missiles with surface-to-air or air-to-air systems; and knocking them out before launch. Australia is so far relying on the first and third of those and not moving fast enough on the middle one.

Last month’s National Defence Strategy and its associated acquisition plan, the Integrated Investment Program, appear to have cut funding for the surface-to-air systems, the engagement component of integrated air and missile defence (IAMD). While a joint air battle management system will be bought under the previously announced AIR 6500 Phase 1 program, the updated acquisition plan says addition of other active missile defence systems await future consideration ‘as technology matures’.

When, then, will Australia field systems for knocking down incoming strike missiles? That just isn’t clear.

Australia’s geography provides some protection, due to the range that strike missiles and possibly their launching aircraft or ships must cover. But Chinese CJ-20 air-launched cruise missiles can fly 1500-2000km after they’re dropped by H-6K bombers that themselves have a combat radius of 3200km. The bombers could fly from China’s Hainan island, which is 4100 km from Darwin.

Meanwhile, Chinese ballistic missiles carrying conventional warheads continue to improve and are approaching ranges threatening to Australia’s north from China, such as the DF-26 with its 4000km range.

As for countering long-range strike missiles, passive measures reduce the likelihood and impact of attacks without engaging the weapons or their launchers. Such measures typically include concealment, deception, dispersion and hardening of infrastructure and facilities. They can help the ADF to operate under attack more effectively and would reduce losses.

It’s also possible to attack launchers or missile inventories before launch to reduce or defeat the threat—using strike forces against strike forces. The National Defence Strategy and acquisition plan put high priority on improving the ADF’s capability to perform ‘impactful projection’, executing precision strike over long distances. This prioritisation, along with a deferral of IAMD investment, means that such offensive operations will need to serve as the ADF’s primary tool to defend against long-range strike missiles.

But finding and destroying mobile missile launchers has been incredibly challenging. Hunting for Scud ballistic missiles and their launchers was a high priority mission in the 1991 Gulf War, yet ‘mobile missiles proved particularly difficult to detect and were never fully suppressed,’ according to the US Air Force.

Things haven’t improved much since then. US officials said in January that two days of attacks against Houthi targets had left the militant group with about ‘three-quarters of its ability to fire missiles and drones at ships transiting the Red Sea.’

Both operations were conducted against adversaries with minimal or compromised air defences. But China has dense and powerful defences against air and missile attack—just the sort of IAMD system that Australia doesn’t possses. Degrading China’s strike missile force using Australian strike capabilities would be extraordinarily difficult.

There are other pitfalls in overreliance on offensive operations. One is that they can result in strategic instability: each side has the incentive to use its strike forces first to knock out the other side’s. That would apply particularly to Australia, since it seems not to be spending enough on defending its strike forces.

Another challenge is that the ranges of cruise missiles and conventional ballistic missiles keep rising. Their possible launch positions therefore become more numerous and more distant. If Australia intends to rely on offensive measures, its strategy implies having a capability and willingness to strike inside China. That would be highly escalatory.

That leaves us with the priority to acquire active defences, ground or air systems for shooting down incoming strike missiles with interceptors. After its performance in the Gulf War, the then current version of the US Patriot system was labelled ‘a nearly total failure’ against Scuds, but such systems have improved dramatically in recent years. Evidence is in the successful interception of more than 300 munitions from Iran by Israel and its allies and Ukraine’s use of ‘highly effective’ modern air defences to successfully defeat countless missile and drone attacks.

A strong strike-missile attack by a major power would severely challenge such surface-to-air systems, and it would be unreasonable to expect them to provide total protection. But what a layered defence could provide is an ability to blunt attacks that come with little or no warning time, including those that might be expected on the first day of a war. They would also buy time, giving offensive operations more opportunity to succeed.

In Ukraine, a lack of air defence missiles caused Kyiv’s largest power plant to be destroyed by Russian missiles. Without sufficient air and missile defences, Australia’s bases and critical infrastructure remain susceptible to missile strikes. Prioritising a more balanced spending plan, including active defences, would be a wise move in today’s missile age. They would help reduce the nation’s vulnerabilities, making coercion more challenging for any adversary.

National Defence Strategy: preparing slowly to strike far

/in

The 2024 National Defence Strategy (NDS) reiterates the importance of a strategy of deterrence by denial suggested in the 2023 Defence Strategic Review. It also reiterates air, sea and land capability decisions already made to support a more hemispheric role for the ADF, in particular to counter the risk of coercion from afar in the next decade.  

But it hardly reinforces deterrence by denial in the shorter term—this decade. 

The current emphasis on deterrence by denial actually extends and deepens a theme in defence policy that goes as far back as the 1987 Defence of Australia white paper; the idea was then called Defence in Depth. The 1987 document said the ADF had to be able to find and deal with an enemy in the sea and air gap to the north of the continent and to defeat forces that managed to land in remote locations. 

The 2024 NDS, supported by the 2024 update of the Integrated Investment Program (IIP), aspires to extend the ADF’s reach to a wider ‘area of primary military interest.’ This was defined in the 2023 Defence Strategic Review (DSR) as ‘encompassing the north-eastern Indian Ocean through the maritime Southeast Asia into the Pacific, including our northern approaches.’ Within this broader hemispheric region, the 2023 document set five key tasks for the ADF: 

to defend Australia and our immediate region … deter through denial any potential adversary’s attempt to project power against Australia through our northern approaches [the sea-air gap] … protect Australia’s economic connection to our region and the world … contribute with our partners to the collective security of the Indo-Pacific; and … contribute with our partners to the maintenance of the global-rules based order. 

The 2024 NDS correctly emphasizes that Defence must now function within a multi-domain operational space, encompassing not only the traditional domains of sea, air and land but also space and cyberspace, and that it must be able to fight in the electromagnetic spectrum. New layers of challenge are added by having to face long-range conventional precision strike by advanced ballistic and cruise missiles, cyber attack and ever-more sophisticated counterspace systems. 

To all that, add the emerging technologies of swarming autonomous systems; the implications of quantum technologies and artificial intelligence for advanced sensors, communications and battlespace management; and the acceleration of the pace of war through hypersonics and directed energy weapons. So, the ADF has a much more complex task than simply defending the sea-air gap. 

Furthermore, our critical infrastructure can be threatened with not only direct attacks but also indirect coercion. This can occur through disruption of sea transportation of vital supplies and other trade and even through the severing of submarine cables that maintain national connectivity with the global internet. 

In this regard, the NDS and IIP get the fundamentals broadly correct. They recognise that Australia is an island nation, so it is only sensible for Defence to prioritise a buildup of naval power at the centre of future ADF ability to carry out five key tasks noted above. 

The basics of this remain acquisition of nuclear powered but conventionally armed submarines (SSNs) and expansion of the Royal Australian Navy surface fleet under the recently released Fleet Review. These are accompanied by re-announcements of long-range strike capabilities that have been progressively approved since 2020. Certainly, the ADF’s long-range strike capabilities will be enhanced and better able to contribute to achieving the five tasks at greater range.  

The boost to naval capabilities, particularly SSN acquisition, will enhance our ability to project power farther from our northern coast. The SSNs will have the flexibility and endurance to remain on station for much longer than the current Collins-class diesel-electric submarines. Defence Minister Richard Marles goes so far as to state that ‘…more than any other capability, this platform will give an adversary pause for thought and hold their assets at risk further from our shores. Our future submarines define projection.’ 

Finally, the army’s ability to undertake littoral warfare will be enhanced, as will its ability to support long-range strike missions through acquisition of highly mobile land-based strike capabilities including HIMARS launcher vehicles and PRsM missiles. 

These are all good steps towards achieving an ability for deterrence by denial. The challenge, though, may be around timing. In launching the NDS and IIP, Marles states that ‘…the strategic problem we are trying to meet, that we are trying to solve, is making sure that in a much less certain world in the future we are able to resist coercion and maintain Australia’s way of life.’  

Yet at the same time, the NDS correctly recognises the rapid worsening of Australia’s strategic outlook, even stating that ‘Australia’s strategic environment has continued to deteriorate since the release of the Defence Strategic Review ….’ With the ending of an assumption of 10 years of strategic warning back in 2020, the challenge now is how to balance investment in new capabilities to meet long-term threats identified in the NDS versus ensuring the ADF is equipped to respond to short-term and immediate risks. So, it was worrying that in responding to media questions, the minister derided concerns about potential ‘worst contingencies that may or may not occur in the next few years’, suggesting that such concerns ‘lack wit’. This is not a helpful observation at a time of increasing strategic peril. 

Like the 2023 DSR, the 2024 NDS and IIP update seem to have a disconnect between their perception of a rapidly rising danger and their approach to meeting it. While preparing for threats in the 2030s and beyond, Australia must also get ready for protracted military operations in worst contingencies this decade. 

That would require the government to be more ambitious in increasing defence spending sooner than suggested in the IIP. The IIP correctly talks about ‘minimum viable capability’ approaches, but timelines stretch out even as threats rapidly approach. So, in addition to extra funding sooner than suggested in the IIP, there would also need to be greater determination to streamline capability acquisition processes and make some radical change in this regard. There are risks ahead that cannot be dismissed, and we must be ready for them. 

Making Japan’s defence spending sustainable

/in

One of the highlights in Japan’s three national security documents released on 16 December 2022—the national security strategy, the national defence strategy and the defence build-up plan—is the commitment to increase defence spending.

The defence build-up plan revealed that the Japanese government will spend approximately 43 trillion yen (US$310 billion) from 2023 to 2027 on defence capability. Japan’s Ministry of Defence budget will increase annually to reach 8.9 trillion yen (US$64.1 billion) in 2027. The 2023 defence budget demonstrates Tokyo’s determination to follow through on its five-year spending commitments under the defence build-up plan. The total budget of more than 6.6 trillion yen (US$47.5 billion) is a 27.5% increase from 2022 and the biggest defence budget in Japan’s post-war history.

But the ‘roughly 2% of GDP’ goal that Prime Minister Fumio Kishida discussed in his press conference following the release of these three documents is slightly misleading. The 2% includes not only the defence budget but also other national-security-related spending such as the Japan Coast Guard budget and national infrastructure investments.

Still, the 2023–2027 budget plan is 60% higher than the 2018–2022 spending plan. As a country that historically spent roughly 1% of its GDP on defence and resisted calls to spend more, Japan has marked a departure from the past in committing to such a considerable increase.

Highlights from the three documents—such as Japan’s acquisition of counterstrike capabilities—have grabbed news headlines. But funding remains a thorny issue. The Liberal Democratic Party–Komeito ruling coalition has been working on fiscal measures that will enable Tokyo to follow through on its defence spending commitments.

In December, based on the LDP–Komeito approved outline, the Ministry of Finance included ‘tax measures to secure financial resources for strengthening defence capabilities’ in its seven-point 2023 tax reform proposal.

The coalition introduced the Defence Fiscal Resource Bill to the National Diet in February. The bill provides the fiscal framework through which the Japanese government will fund the defence spending increase—which is essentially a mixed package of the establishment of the defence enhancement fund and the incremental phased increase of corporate, personal income and tobacco taxes. The bill passed the House of Representatives on 23 May and, following approval by the House of Councillors on 16 June, became law.

The opposition parties, including the Constitutional Democratic Party, vowed to block the bill. But the large majority that the LDP–Komeito ruling coalition enjoys in both houses of the Diet, along with support from the conservative Japan Innovation Party, cleared the way for the bill’s passage.

Even though Kishida won the legislative battle, whether the public will support it remains highly questionable.

In fairness, the majority of the Japanese public supported a defence spending increase. Polls taken by media outlets across the ideological spectrum throughout 2022 consistently showed that the public mostly supported a defence spending increase. Three separate media polls taken in April, October and December 2022 show that over half of the respondents supported a defence spending increase. Even a May 2022 poll by the Mainichi Shimbun, known for its criticism of expansive defence policy, shows 76% public support for such an increase.

But the public resisted funding this defence spending increase through higher taxes. Public resistance to tax increases began showing in late 2022. Two polls in November and December showed that more than 60% of the public disapproved of such a tax hike. This public pushback continues in 2023. Polls in January and February showed that 71% and 64% of respondents were against increasing taxes to fund a defence budget increase.

A 7 May public opinion poll revealed that nearly 90% of the respondents are concerned about a military crisis in Taiwan and more than 60% support Japan acquiring counterstrike capabilities. But 80% are opposed to financing defence spending through tax increases.

Plus, Kishida might have missed the chance to gain public support for the defence tax hike by bringing the case to the public. Two separate polls conducted in January indicated that 78% and 63% of respondents thought that Kishida should dissolve the lower house and call an election before implementing the defence tax hike. But with his approval rating just recovering to 45% following a successful G7 summit in Hiroshima, Kishida decided not to dissolve the lower house at least in the near future.

The Japanese public seem already to be reacting negatively to Kishida’s choice. The 17–18 June poll conducted by Kyodo News shows that Kishida’s approval rating has dropped by more than 6 points to 40.8%. While the defence-related tax hike wasn’t the only reason for the decline in his approval rating, it indicates that Kishida’s tactics of steamrolling widespread public resistance with the power of majority might work in the short term, but may undermine the sustainability of Japan’s increased defence spending over time.

Defence budget set to take a big inflationary hit

/in

The size of the cuts that Australia’s Defence Department must make to existing programs to create room for the recommendations of the defence strategic review will be dictated in part by the persistence of inflation.

The breakout of inflation was barely recognised at the time of the March 2022 budget. The Reserve Bank’s cash rate still stood at a rock-bottom 0.1% and both the bank and Treasury believed a rise in international prices reflected short-term factors that would soon pass.

These included disruptions to supply chains caused by the pandemic, interruptions to energy supplies caused by Russia’s invasion of the Ukraine and the disruption to food supplies caused by extensive flooding in late 2021.

Treasury expected that the consumer price index would reach a peak of 4.25% in the three months to June 2022 and then drop back to 3% by the current June quarter. The RBA was even more confident, tipping ahead of last year’s budget that inflation wouldn’t surpass 3.75% and would be back to 2.75% by now.

Instead, inflation accelerated to 6.1% by June 2022 and touched 7.8% by March this year, the latest complete CPI survey. Last month’s budget stayed with optimism: Treasury predicted that inflation would be back to 6% by the current quarter and would be down to 3.25% by June next year.

Inflation hits the budgets of every government department (and every business and household), but Defence is unusually exposed because of its large capital acquisition program, which involves multi-year commitments that are often exposed to cost increases. Defence has capital purchases this year of $15.1 billion, much higher than the next-ranked Department of Social Security’s capital purchases of $866 million.

Defence inflation is difficult to untangle. There is intergenerational cost inflation, with each successive generation of defence equipment involving greater complexity, capability and expense than the one before. The development costs of equipment involving new technology are inherently uncertain, while new technology frequently involves rare or hard to fabricate materials, with high costs.

Major acquisition programs are subject to cost blowouts, only part of which are due to ‘inflation’; changes in specifications, delays and poor planning contribute to the rest. Then there’s the lack of competition in defence procurement, which, in the US, is behind the stories of US$1,400 toilet seat lids, US$1,260 coffee cups and US$436 hammers.

Defence equipment is typically manufactured without the economies of scale that would be required in the private sector. One US study found that over a 70-year period, defence costs rose 30% faster than prices across the economy.

While Defence deals with inflationary pressures across the full spread of its operations, simple construction materials have contributed to the difficulty of its budget management. The price of concrete has risen by 18% over the past two years, and steel is up 40%.

Treasury’s updated forecasts for inflation in the 2023–24 budget translate to a reduction in Defence’s purchasing power of between 5% and 6% a year, relative to the forecasts made in the budget delivered in March 2022.

The latest forecasts assume that inflation returns to ‘normal’ levels rapidly; however, the loss of purchasing power, incurred as prices rose 6% over the last year and a similar amount the year before, is permanent.

There have been some encouraging signs—for example, excluding ‘volatile’ prices like energy and food, the CPI had come back from a peak of 7.5% in October to 5.5% by April. Oil and shipping prices have fallen sharply and are back to pre-pandemic levels.

On the other hand, the cost of market services has risen by 6.7%, while electricity prices are up 15.2% and housing 8.9%. The trend of continued inflation in services is evident in other advanced nations, and reflects the continued ‘overheating’ of economies after years of ultra-low interest rates and excessive government stimulus.

The share of the population with a job is close to a record high, the number unemployed is close to a record low, and there are almost as many unfilled job vacancies as there are people without a job and looking for one. Business is operating with less spare capacity than at any time in the last 40 years. It would be surprising to see inflation fall far while these factors prevail.

It appears likely, therefore, that inflation will take longer to bring under control than either the RBA or Treasury is predicting. If inflation is still at 5.5% by the middle of next year, and still at 4.75% by June 2025, the erosion in the value of the defence dollar would rise to almost 11% over 2024–25. The impact of inflation is cumulative—the lost value of a deflated currency is never regained.

As ASPI’s 2023 defence budget brief demonstrated, the core provision of defence funding is lower in this year’s budget than in the budget of March 2022, once compensation for adverse foreign exchange movements is taken into account. Excluding that compensation, defence funding totals $152.5 billion between 2023–24 and 2025–26, down from $154 billion over the same period in the March 2022 budget.

Defence has to squeeze between $7.3 billion and $7.8 billion of new and otherwise unfunded spending into that reduced budget allowance, covering items recommended in the defence review, such as the hardening of northern bases, the nuclear-powered submarines and a long-range strike capability.

Before looking at inflation, this suggests Defence is having to make new purchases equivalent to around 4% of its total budget with total resources that are about 1% less, implying that savings equivalent to 5% of its budget will have to be found.

The breakout of inflation means that, on the current forecasts from Treasury, the defence dollar buys 5% less than it expected in March last year. This would require savings equivalent to roughly 10% of the defence budget to be found to finance the new priorities under the defence review.

If inflation lingers at around 5%, the savings required would rise to roughly 15%. There is doubtless fat in the defence budget, as there is in all departmental budgets, but trying to achieve a massive reorientation in defence priorities consistent with the recommendations of the review while at the same time seeking huge savings is unlikely to generate an outcome satisfactory to anyone.

Budgeting for Australia’s nuclear-powered submarines

/in

The upper estimate of $368 billion for Australia’s acquisition of eight nuclear-powered submarines is an impossibly large number. Stacked in $100 bills, each 0.14 millimetre thick, the pile would rise to about 500 kilometres. You could build 1,000 40-storey buildings in Sydney, buy every single house and apartment in Adelaide, or make a gift of $40,000 to every household in the country.

The figure is more conjectural than realistic. It’s what you get when you estimate that the program will add about 0.15% of GDP to defence spending over a 30-year period. As the Australian Financial Review’s Phil Coorey noted, the National Disability Insurance Scheme will cost $2 trillion over the same time.

With GDP currently around $2,000 billion a year, a 0.15% increase would be equivalent to around $3 billion a year, adding roughly 8% to the defence budget.

That sounds less scary. Defence Minister Richard Marles has endeavoured to make it sound even more benign, noting that around half the sum required over the next decade has already been allocated in the budget to pay for the now-cancelled French submarines and suggesting it won’t really cost taxpayers anything over the next four years.

Two-thirds of the $9 billion cost in that period is offset against savings from not buying the French submarines, and the $3 billion balance is to be absorbed elsewhere in the defence budget.

Although the early phases of the project are relatively clear, with $2.5 billion to be given to the United States to upgrade its shipyard and another $2 billion to upgrade the Adelaide submarine yard, the cost of designing and building new nuclear submarines from scratch in collaboration with the United Kingdom is beyond any realistic reckoning. It could be 0.15% of GDP or a multiple of that. It is unlikely to be less. The timing of that spending is similarly beyond calculation.

Marles commented that the investment in submarines was part of a build-up in defence spending from 2% of GDP to 2.2%. The 2020 defence strategic update noted that defence spending was no longer linked to GDP, to avoid having to adjust it whenever the pace of economic growth changed. However, the measure remains a useful benchmark both to compare defence with other calls on the public purse and to assess international relativities.

When the defence budget was cut by $5 billion in 2012 in a vain effort to return the federal budget to surplus after the global financial crisis, it was noted that defence spending had dropped to 1.56% of GDP, the lowest level since 1938. Australia had a substantial overseas military commitment at the time in Afghanistan, but the war on terror was essentially ‘low tech’.

Geopolitics has become a lot more complex since then.

China has emerged as an assertive global power, intensifying a rivalry with the United States. North Korea has become a capable nuclear power and efforts to prevent Iran from a similar achievement have faltered. In the wake of its invasion of the Ukraine, Russia now defines the US, and by extension the West, as an ‘existential threat’.

Without entering a debate over whether nuclear submarines are the best response to this more menacing world, it’s easy to see why successive governments have decided a higher level of defence spending is warranted. The question remains whether Australia can afford it.

The state of federal finances will be updated in next month’s budget, but the new Labor government’s first budget, released last October, painted a sombre picture of the outlook, with slowing world and domestic growth as global economies wrestled with spiralling energy prices and inflation. The previous government had anticipated paring away the budget deficit and bringing net debt back to zero before the end of the decade, but the October update saw the deficit stuck at 2% of GDP for years to come and debt continuing to climb.

Only 10 of the 36 advanced nations in the International Monetary Fund’s latest budget survey are running budget surpluses, and the average deficit is about twice the size of Australia’s. However, Australia has an unusual vulnerability. For most countries, the prices fetched by their exports and paid for their imports are fairly stable. In inflationary times like now, both are rising, but the relativity between the cost of imports and the earnings from exports doesn’t change a great deal from one year to the next.

Australia’s exports, by contrast, are subject to the wild swings of commodity markets, while imports are overwhelmingly manufactured goods with unit costs under downward pressure as the economies of scale improve. The relationship between export and import prices (known as the terms of trade) matters for the federal budget because roughly a third of the income from exports flows to the government in tax revenue.

Australia’s terms of trade have enjoyed an almost 20-year boom, thanks to the rapid development of China. The terms of trade is measured as an index, and for most of the previous 50 years to 2005, it averaged around 60 points, rarely deviating by more than plus or minus 10 points. However, it now sits at 110 points, almost double the historical average. That translates into roughly a $275 billion a year boost to the national economy, with $90 billion flowing to the federal budget.

Until the early 2000s, it was thought that Australia’s terms of trade were in a slow but long-term decline. The thinking was that economies would increasingly value high technology, while the steady improvement in economies of scale in the resources sector would bring a reduction in costs.

Instead, the China boom has elevated Australia close to the top of world rankings of living standards. It costs the big miners less than US$20 a tonne to dig up the iron ore that they have lately been selling to China for US$125. It can be argued that Australia’s investment in nuclear submarines is being financed by China.

There’s data for Australia’s terms of trade going back 150 years, and historically, booms have always been followed by busts. The danger for Australia and its plan to acquire nuclear submarines is that the premium for Australia’s exports disappears.

A global recession would do it, but so too would a move by China to a slower, less infrastructure-intensive growth path. Without the China premium on our exports, a budget deficit of 2% of GDP could blow out to three or four times that. With credit-rating downgrades, there would be pressure from global financial markets for the government to slash spending wherever it could, including defence.

The alternative would be to raise taxes. Among advanced nations, Australia is one of the lowest taxing countries; only the US, South Korea and Switzerland raise less as a share of GDP. Australia’s taxes raise 27% of GDP, compared to an advanced nation average of 32% and France at 45%.

Defence is not the only sector requiring more federal funding, with ever-increasing demands for social spending, industry support and infrastructure. The time to be raising taxes to strengthen the budget is before a crisis strikes—preferably now.

Affording Australia’s defence

/in

The 2023 defence strategic review, which sets out how Australia can sustain its security and sovereignty, has been handed to the government. In terms of the concept of warning time developed in the 1987 defence white paper, we’ve moved from a force structure designed to deal with ‘escalated low-level conflict’ to one able to engage in ‘more substantial conflict’. The ‘force in being’ now must handle high-level threats to our interests in the region while facing the prospect of attacks on the homeland. Warning time is now close to non-existent. It’s clear that the defence-of-Australia concept is evolving to one of ‘deterrence at a distance’ intended to block entry to our immediate approaches.

Defence Minister Richard Marles made this clear in a speech to the Sydney Institute last year:

Australia’s defence capabilities cannot meet those of major powers. Australian statecraft is only viable if it is underpinned by the ability to project force and power: to deter military threats, and defend Australia’s national interests in our immediate region.

And so I believe the cornerstone of future Australian strategic thought will be impactful projection. We must invest in targeted capabilities that enable us to hold potential adversaries’ forces at risk at a distance and increase the calculated cost of aggression against Australia and its interests. And we must be able to do this through the full spectrum of proportionate response.

The 1987 study was about layered defence starting in our area of direct military interest, defined geographically as the archipelago to our north and then back to the continent. The distinction between that and our then area of strategic interest, roughly Southeast Asia and the northeast Indian Ocean, is now blurred. Our weapons systems were tailored to a highly mobile army across our north supported by an air force deployable from northern bases with submarines and surface warships directed towards the four choke points through the archipelago. They were backed up by an effective surveillance system a key part of which was our over-the-horizon radar network. These are still important, but the focus now will be on missiles deployed with all three services in large numbers, and mines. A key element will be nuclear-powered submarines capable of lengthy deployments at the furthest ranges.

The problem for Marles is that funding of this program comes off a massively reduced financial base. That’s a consequence of a post–Cold War peace dividend effectively being taken when none was justified. In 1987, defence had around 9% of the total budget, and about 2.5% of GDP. As significant in funding the 1987 program was a policy permitting the Defence Department to keep the product of sales and privatisations. While the privatisations didn’t raise large amounts of money, the removal of effective subsidy obligations did, as did reforms to practices in the factories remaining government owned. As I recollect, this added about 3% real growth in outlays. Nothing like that is available now.

It’s important to remember that nothing created in the force structure and facilities in the 1987 white paper related to Cold War contingencies. That point was made frequently through it. While contributions could be drawn for allied efforts from the force structured for the defence of Australia, those contingencies would not determine that structure.

The paper contained detailed arguments on how new facilities, weapon systems, personnel deployments and industry related to dealing with capabilities evolving, or deployable, within our area of direct military interest. They were seen as affordable—just—within the budgeted amount. There was no peace dividend to be taken or justified. And yet from the 1990s it was taken—and it massively depleted the defence base.

In terms of weapon systems, the effect can be seen most directly in the navy. An original submarine decision to have an essential eight saw two simply disappear, though controversy also influenced that. The 17 major combat vessels—three guided missile destroyers, six guided missile frigates and eight Anzac-class frigates—was the proposed force structure, but that idea, too, disappeared. That force had been designed to patrol the routes through the archipelago. We acknowledged they weren’t quite enough, but hoped the New Zealanders would take four Anzacs and that would provide the numbers. Our new air warfare destroyers were supposed to replace the DDGs. Nothing did. They replaced the six FFs. In capability terms, it was a massive peace dividend.

Marles doesn’t simply confront a funding base massively lower than that in 1987. He confronts the cost of 25 years of underfunding on the 1987 target. Peerless ASPI senior analyst Marcus Hellyer confirmed for me in contemporary budget terms the two figures then and now. He pointed out that if we used the ‘expenses method’ and went from 6.1% to 9%, the 1987 figure in contemporary terms would yield a massive increase of nearly 50%, to $18 billion—from $38.3 billion to $56.3 billion. If the ‘appropriation method’ were used and went from 7.77% to 9% of payments, it’s about a 16% increase to $7.8 billion—from $48.6 billion to $56.3 billion.

That would be an $8 billion increase in the next budget. Contemplate what our defence forces would look like now if we threaded that $8 billion back over 25 years. It’s likely that the critical Sky Guardian program of armed drones would not have been cancelled to help pay for the REDSPICE cybersecurity program. So we move from ‘defence of Australia’ to ‘deterrence from Australia’, which bears an enormous burden having been severely short-changed.

Defence funding will need a massive rethink. It’s dangerous to make the long-term, but essential, nuclear submarine program the enemy of our ability to defend ourselves now. Assuming we survive the next 25 years, those submarines are a long-term guarantee. It might be sensible to carve them out of the general defence vote and run them transparently separately. Maybe carve out REDSPICE, too. It serves broader government purposes. We are very good at cyber. However, we have already seen the expense of developing it seriously damage the defence program. That program needs the bulk of the missing funding restored, however close the government is prepared to bring future spending to the previous levels. The submarines eventually will need much more.

When looked at in macro terms, an extra $10–15 billion on the outlays side of the budget isn’t great. When viewed in fraught Expenditure Review Committee (ERC) meetings, a billion-dollar proposal—let alone $10 billion—will meet howls of anguish. The two most frightening expressions in the English language are the orders ‘fix bayonets’ and ‘offsets must be offered for the costs of new policy’. In ERC terms, they are related.

Defending the country is the main and exclusive constitutional duty of the federal government. Paul Keating as treasurer once told me he wanted to consider defence last at ERC meetings because if the committee needed the odd $100 million it could be obtained from defence forward guidance. Now it needs to be considered first if this review is going to do the job it was established to do. With the massive and very necessary demands on the government, that will be very difficult. Still, a start should be made.

The real costs of Australia’s defence budget ‘blowout’

/in

Every year the Australian defence commentariat replays a ritualised dance that goes like this. First, the Australian National Audit Office releases its major projects report providing detailed information on the progress of around 25 of the Department of Defence’s largest acquisition projects. It includes a table titled ‘Budget variations post second pass approval’ (that is, government approval to commence acquisition of a particular capability). Last year, the table summed to $24.2 billion.

The media then performs its role and publishes stories about defence budget ‘blowouts’, reinforcing the public’s deeply held view that Defence couldn’t manage a kindergarten bake sale without the cost blowing out by several billion dollars.

I then run a piece in The Strategist explaining why the dollar figure for projects exceeding their approved budget is actually much lower. The term Defence uses for this is ‘real cost increase’, which is way less sexy than ‘cost blowout’.

Most of the variations come from two factors. The first is increases in scope. You want an additional 58 F-35As? You need to pay for them by increasing the project’s budget. That’s not a blowout. It’s a staged acquisition strategy (or, occasionally, an opportunity to use the defence portfolio’s underspend before it evaporates).

The second factor is fluctuations in exchange rates. Defence is compensated for a decline in the Australian dollar in order to preserve its buying power. This isn’t a blowout either. It shows up as a budget increase, but it’s not a ‘real’ increase (and with the Aussie dollar plummeting against the greenback, get ready for some extremely large upward adjustments in the October budget). The truth is, very few of Defence’s acquisition projects actually require real cost increases.

Since hope springs eternal, I thought we might be able to escape this version of Groundhog Day if I set the issues out in plain English—which I did in a report earlier this year on the cost of military equipment.

Despite that, the dance started a little earlier this time around when the government pre-empted the ANAO by releasing to the media a list of $6.5 billion in ‘blowouts’ that occurred under the previous government. While the figure is less than the ANAO’s $24.2 billion, most of the increases in the latest list are again due to changes in scope and adjustments for exchange rates rather than real cost increases. For example, the $2,366 million increase for the F-35A is mainly exchange rate compensation. The $1,784 million increase for the P-8A Poseidon maritime patrol aircraft is due to the acquisition of additional aircraft and exchange rates. It’s a similar story for the EA-18G Growler electronic attack aircraft.

The figure for real cost increases for the projects on the ANAO’s latest list is only a small fraction of the $6.5 billion. Other than a $243 million increase for the civil–military air traffic management system that occurred nearly five years ago, there’s not much there. Defence’s biggest real cost increase was $1.2 billion for the air warfare destroyer project—but that’s not on this list since the project is complete. And once that project’s numbers are finalised, it’s likely it won’t need all of that.

Incidentally, one element that is consistently overlooked in the dance is that projects going over budget are more than outweighed by projects that underspend against their approved budgets. Indeed, the Growlers and P-8As will come in under budget, not over.

Schedules are a more problematic issue. The government’s list has a total of 1,173 months—almost 98 years—of delays. It’s no secret that many defence projects have experienced delays, but even here the issues aren’t black and white. For some projects there are straightforward explanations. Take, for example, the P-8A project. The government ordered six additional aircraft after the initial eight. If you order them later, they will be delivered later, so the original date for final operational capability will necessarily move.

Even the projects with real delays generally have delivered most of their intended capability but haven’t been closed out because there are some outstanding elements. The MRH-90 Taipan helicopter project has a 123-month delay to full operational capability, but its 47 helicopters were delivered years ago and have been in service (their unreliability and high cost of operation that prompted the previous government to announce their early retirement is a separate but not entirely unrelated issue). The Collins-class submarine reliability and sustainment project is 108 months late, but it’s a program delivering a large number of improvements and upgrades, most of which were successfully completed long ago.

But that doesn’t mean there’s nothing to see here. There are issues that need attention. On cost, the public obsession with blowouts reinforces the wrong behaviours in Defence. It develops second-pass cost estimates extremely conservatively, putting risk margins on top of risk margins so that there’s virtually no prospect of going over budget. But that can tie up funds that could be used for other priorities. If Defence was operating with a more commercial mindset, it would accept a little more risk and estimate its costs a little more leanly. But that would mean the government (and the media and the public) would need to accept that some projects would go over budget.

We also shouldn’t ignore the fact that Defence’s estimates have often increased significantly before the second pass. For example, Deputy Prime Minister and Defence Minister Richard Marles referred to a $15 billion increase in the estimate for the future frigate program from $30 billion to $45 billion. That’s not unique. As a project moves from the recognition of a future capability gap that could have many possible solutions to identification of the actual equipment to be acquired, Defence’s assumptions about threats, requirements, technology, quantity, and so on can change. Consequently, the cost estimate will change, often dramatically. This isn’t a budget blowout per se, since there’s no approved budget to blow. But when numerous projects behave this way, it puts pressure on the overall affordability of Defence’s capability plan. The scrapped submarine program went from $50 billion (inflation-adjusted dollars) to $80–90 billion. A similar trajectory for the nuclear submarine program will be very hard to manage.

Regarding schedule, many delays are real and affect delivery of frontline capability. As repeated reviews have pointed out, there are many factors at work: Defence seeking 110% solutions when a 90% solution will do; industry overpromising; a lack of enough qualified people in Defence and industry to deliver; excessive process and documentation requirements; and so on.

The delays illustrate the disconnection between our current strategic circumstances and Defence’s business processes. If we don’t have warning time for impeding conflict, we can’t keep choosing capabilities that take so long to deliver—whether they’re on time or not.

So it’s a good step that the government also announced a range of measures aimed at improving Defence’s performance. These involve more frequent and earlier reporting to ministers. Closer government attention is a good thing, but nothing focuses the mind like greater public scrutiny, so it would also be good to see more information provided to the parliament and public.

Any solution will require multiple lines of effort. Perhaps the most important one will involve all of us abandoning our peacetime mentality around risk and reward. We can’t keep making the same kinds of acquisition choices and employing the same business processes that got us here. A new approach will involve a different risk appetite from the government, parliament, Defence, the media and the public.

As the old saying goes, ‘You want fast, cheap and good? Pick two.’ If we want capability fast, we either need to moderate our requirements or accept that it could cost more. If getting capability faster results in sometimes having to pay more than expected, we all have to resist the temptation to run easy headlines about cost blowouts—otherwise, Defence will never change its risk-averse behaviours.

Defence spending and industry policies must reflect dangerous strategic circumstances

/in

Dominating the debate on Australia’s defence-capability development is a long list of expensive new weapons to buy. But there are two broader issues to consider: the likely cost of development substantially exceeding the Defence Department’s planned appropriations and a dearth of ideas on how additional funding can be found against the backdrop of Australia’s high public debt and poor productivity performance. Some of the implications of those issues for the defence strategic review are examined in my Strategic Insight report released today.

Affordability may ultimately determine the outcome of the review—remembering the adage that ‘strategic policy without money is not strategic policy’. In that context, the government appears reluctant to extend defence expenditure much beyond 2% of GDP for an economy whose prospects are difficult to predict.

The obstacles to Defence securing additional financial resources begin with intense competition from other public-policy priorities ranging from health care to environmental protection. They extend to whether the department’s existing budget is insulated fully from the effects of inflation, the real cost growth that accompanies an inexorable shift to more advanced weaponry, and the additional costs of stockpiling materiel to meet the demands of a more challenging strategic environment.

Adding to the hurdle of attracting additional funding is the high cost of potential new weapons programs. Those are led by the proposed acquisition of a fleet of nuclear-powered submarines. However, they extend to the possibility of purchasing of a bridging fleet of conventionally powered submarines, enhancing the firepower of offshore patrol vessels, and providing the navy with more destroyers.

Beyond the naval arena, any attempt to add to the Australian Defence Force’s arsenal by purchasing B-21 bombers and long-range land-based missiles would also be expensive. The money already set aside for the manufacture of missiles in Australia seems little more than seed funding for a more costly venture if domestic sourcing is to have an appreciable effect on defence self-reliance.

There are few signs of a willingness to offset outlays on those and other programs beyond Defence’s current financial reach by altering procurement of the Hunter-class frigates or infantry fighting vehicles. Expectations of job creation for both initiatives have already been ignited.

None of that necessarily precludes a significant increase in funding for Defence. But the obstacles to bolstering the department’s budget make the pursuit of value for money imperative across the capability spectrum. At the very least, a higher level of resourcing in response to the nation’s more immediate strategic needs should be accompanied by efforts to save money later.

Avoiding a significant price premium for preferring the domestic over foreign supply of major weapons platforms and systems—through a more targeted approach to Australian industry participation—might be among the few options available to Defence to boost its purchasing power. Conventionally powered submarines, destroyers and military vehicles are examples of where Defence should gain by accessing whatever spare capacity overseas suppliers possess.

As my report explains, that option need not detract from Australia’s independence or economic welfare. Available data indicates that much can be achieved if at least part of what’s saved can be channelled into other areas with a domestic focus. Those include the critical industrial capabilities that must be kept onshore for military–strategic reasons, technologies sponsored under AUKUS, and critical technologies in the national interest many of which are oriented towards the defence effort. To coordinate and expedite such a broad array of activities, the creation of an Australian version of the US Defense Advanced Research Projects Agency, or DARPA, might help.

If carefully administered, redirected domestic investment can deliver the spillovers of new knowledge that drive economic expansion. It can strengthen Australia’s role in international strategic partnerships focused increasingly on trade in military technologies—but dependent on reciprocity. Most reinvestment can commence within years rather than decades and favours innovative small to medium-sized enterprises. South Australia is well placed to attract much of the funding.

More broadly, avoiding price premiums for some materiel and putting what’s saved to better use could bolster the military preparedness and industrial productivity that jointly underpin Australia’s long-term security—while allowing necessary commitments to domestic assembly to be honoured. It could facilitate an increase in military spending now by demonstrating to taxpayers the enduring importance placed by Defence on avoiding waste, not only by ensuring the weapons platform and systems purchased are functional but ensuring those items are sourced in the most cost-effective manner. The economy should gain more jobs faster across a larger, more efficient and increasingly diverse advanced manufacturing base.

Realising those benefits depends on avoiding the defence industry policy pitfalls of the recent past. A short economic history of the cancelled Attack-class submarine program, provided in my report, points to where improvements can be made. When the current policy was formulated, Australia enjoyed a relatively benign strategic environment and a favourable fiscal climate. Much has changed since then. Linking an updated capability plan to an outdated industry policy is, at best, a high-risk venture. More realistically, it represents a path to disappointment on both fronts.

The work of the defence strategic review, including input from the nuclear-powered submarine taskforce, is an ideal opportunity to reset a poorly structured approach to defence industry development fuelled by misplaced optimism and geared to a bygone era. Tight reporting timeframes may prevent detailed solutions from being devised, especially by the review team. Nonetheless, establishing a set of guiding principles for reform should be achievable.

Policy, Guns and Money: The cost of Defence

/in

This week, ASPI released the 21st edition of its annual Cost of Defence budget brief, Australia’s most comprehensive analysis of defence spending. In this podcast episode, ASPI’s defence, strategy and national security program director Michael Shoebridge speaks with the report’s lead author, ASPI senior analyst Marcus Hellyer, about the biggest areas of spending for Defence and challenges for the department, as well as the difficult choices the new government faces given supply-chain disruptions, inflation and the conflict in Ukraine.