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.

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.

A key challenge for the defence budget is inflation, which eats into not just the average Aussie family’s buying power, but also the government’s. The higher the rate of inflation, the more the defence budget will be eroded in real terms. Analysts in the US, where inflation is running at around 8%, have expressed concern about its impact on the nation’s defence budget. But Australia’s Department of Defence won’t be immune from inflation’s debilitating effects either.

Over the past two decades, Australia has had relatively low rates of inflation, with 2.25–2.50% being the norm (using the consumer price index). We can assume that the 10-year funding lines included in the 2016 defence white paper and 2020 defence strategic update were developed using that rate of inflation.

But the Covid-19 pandemic has changed that stable picture. First, we had a year of deflation in 2019–20, but since then inflation has increased beyond the norms of recent history. It hit 3.5% in 2020–21.

The government predicted 1.75% for 2021–22 but had to revise that up to 4.25% in the 2022–23 budget. That may need further revision; on 27 April the Australian Bureau of Statistics reported that inflation had risen by 5.1% over the 12 months to March. The governor of the Reserve Bank of Australia said this week that it could hit 6% before it moderates.

Australian government inflation, actual and predicted, 2019–20 to 2025–26 (%)

Source: Budget paper no. 1.

In fairness to the government, accuracy hasn’t been a feature of anybody’s economic predictions in the age of Covid. At the moment, a lot of money (in part generated by various Covid relief measures) has been seeking a reduced amount of goods and services (caused by supply-chain disruptions, lack of workers, sanctions in the energy sector and so on), driving inflation. The government is assuming those disruptions will end and inflation will decrease to 3.0% in 2022–23 and eventually back to a more ‘normal’ 2.5% by the end of the forward estimates. I’m not going to argue for any particular number, but when we’re thinking about risks, it can be helpful to consider scenarios.

Let’s start with the government’s own numbers. Already, the rise in inflation in 2021–22 from the government’s prediction of 1.75% at the start of the financial year to its current estimate of 4.25% has had the effect of eroding more than $700 million from the defence budget in real terms. Using the inflation predictions in the 2022–23 budget papers results in a further loss of $1.4 billion in 2022–23. By the end of the forward estimates in 2025–26, the defence budget will be 3.7% lower in real terms. That might not sound like much, but it represents a cumulative loss of buying power of around $6.8 billion over the forward estimates and $15.2 billion over the decade.

To give a sense of scale, this year the planned spending on naval shipbuilding is $1.6 billion. Nearly that much has already evaporated this year alone even before the shortfalls compound over time.

That’s if we use the government’s official inflation predictions. But we can generate more worrying scenarios. One in which inflation hits 5% but returns to ‘normal’ more slowly, not getting there until late this decade, produces a cumulative reduction in real terms of $16 billion over the forward estimates and $45 billion over the decade (scenario 1 in the figure below). A second scenario in which inflation of 5% becomes the new normal results in a 20% annual reduction in real terms by the end of the decade and a cumulative reduction of $54 billion. A reduction in real buying power of that scale will have a huge impact on Defence.

Effects of inflation on the defence budget (2021–22 real $ million)

Source: ASPI modelling.

We should also bear in mind that around two-thirds of Defence’s equipment acquisition budget goes overseas, largely to the US. So even if inflation moderates here, Defence’s buying power can still be eroded by cost increases overseas.

In sum, if inflation remains above historical levels, it will quickly eat into Defence’s buying power even if whichever government is formed after the election adheres to the funding outlined in the 2020 defence strategic update. To manage that, the government will need to accept reductions in capability or increase the defence budget just to acquire and support Defence’s currently planned capability. That’s before it even considers any increases to meet our worsening strategic circumstances.

ASPI celebrates its 20th anniversary this year. This series looks at ASPI’s work since its creation in August 2001.

‘Strategy without money is not strategy.’

— Arthur Tange, Secretary of the Department of Defence, 1970–1979*

On the cover of ASPI’s first defence budget analysis, The cost of defence 2002–2003, there’s a small picture of a couple of Australian Army vehicles inset into a larger picture of the Department of Defence’s administrative offices at Russell in Canberra.

Below the pictures is a dollar amount, spelled out in words: ‘Thirty-nine million, nine hundred and ninety-one thousand, eight hundred and ninety-eight dollars and sixty-three cents per day’.

That was what Australia budgeted then, every day, to pay for defence. An updated daily dollar figure has since been on the cover of every annual ASPI evaluation of the defence budget.

For 2021–22, the spelled out number was ‘One hundred & twenty-two million, two hundred & forty-two thousand, seven hundred and thirty-nine dollars and seventy-three cents per day’.

Tracking the cash for the kit, then giving the clearest of explanations, has been an enduring feature of the institute’s approach to its examination of Australia’s defence organisation.

The second annual budget brief introduced what became an intermittent feature—a cartoon on the cover. Among the cover greatest hits: a cartoon of a submarine firing two torpedoes rendered as barrels loaded with cash, with the words ‘Pork barrels away!’ issuing from the conning tower; a paper aeroplane labelled ‘White paper’, with one wing on fire and trailing smoke; a bayonet charge by uniformed kangaroos and koalas, all wearing slouch hats; and a senior officer with many medals smiling at a piece of paper labelled ‘Defence budget’, exclaiming ‘Incoming’ as showers of bank notes fall from the sky.

The cartoons are fun with high purpose.

The official presentation of the defence budget had always been notoriously opaque and incomprehensible, Hugh White wrote in 2016, even to people within government and defence: ‘ASPI believed that it would be impossible to foster a more rational and better-informed debate on defence priorities without a clear understanding of how the money was being spent and what things cost.’

For maximum impact, this analysis has to be published only a few weeks after the federal budget is announced in early May, not least to help inform the Senate estimates hearings that begin around the end of May. Recalling the first 2002–03 report, White wrote:

After an astonishing marathon effort, Mark Thomson duly produced the first of what has become an annual series of ASPI defence budget briefs, which was launched in Parliament House in late May. This laid out in clear terms just what the defence budget was being spent on, and how well the numbers added up, as well as including clear recommendations for what could be done better. This immediately established ASPI as the authoritative source of information on and analysis of the hard nuts and bolts of defence policy.

After a decade watching Thomson do his annual May marathon as a frantic sprint, Andrew Davies pronounced: ‘Every year I get to watch Mark Thomson pull off a remarkable feat of “extreme analysis”, as he cranks out 260 pages of the annual Cost of Defence report in the couple of weeks after the federal budget is released. (It’s a bit like extreme ironing, but with fewer shirts and more graphs.)’

Extreme ironing involves taking an iron and ironing board up mountains, on bikes, on the tops of cars, on parachutes, on skis, and in the midst of war zones. For Canberra, Thomson’s feat of extreme analysis was equally as impressive.

Not only did he explain the defence organisation to everybody else in government, politics and bureaucracy, he helped explain Defence to itself.

The sprawling Defence beast was offered a comprehensive yet sharp understanding of its own nature.

Journalists in the parliamentary press gallery quickly embraced Thomson’s deep understanding and clear exposition. He became a unique resource on the day of the federal budget’s release, when reporters spend six hours in the ‘lock-up’, confined in parliamentary committee rooms with embargoed copies of the budget until the treasurer rises to speak at 7.30pm. For defence writers, the most welcome arrival (aside from the coffee and sandwiches) was the smiling, lanky figure of Mark Thomson (also locked up) ready to offer a burst of analysis and explanation. The coffee quality was so-so, but the budget-night journalism on Defence got the Thomson version of intellectual caffeine.

According to the Australian Financial Review, the influence of Thomson’s analysis gave him ‘power’ in the way Canberra dealt with Defence. The paper published an annual list of the most powerful people in Australia—wielding overt, covert or cultural power—and one sector was the five most powerful people in defence. Mark Thomson got the fifth spot in the list in 2004, 2006, 2007, 2010 and 2011. In the first year he appeared, the list ran: prime minister, defence minister, Defence secretary, chief of the Australian Defence Force, and at number 5, Mark Thomson, with this explanation from Geoffrey Barker:

Mark who? A new name on the power list. Dr Thomson is budget and management analyst at the Australian Strategic Policy Institute. He has single-handedly over the past three years made the labyrinthine Defence budget transparent and accessible through his superb post-budget briefs for ASPI. His insights are widely admired and sought in defence, industry and foreign policy circles.

The 2006 list lauded the ‘unprecedented clarity’ Thomson brought to Defence spending, making him ‘a powerful and respected Defence insider’. In 2007, the list called him a ‘star’. In 2010, John Kerin wrote that Thomson ensured ‘the government provides more certainty for the defence industry on weapons’. In 2011, Kerin said that Thomson’s review of the budget was ‘once again compulsory reading. Its release is even more anticipated than the budget itself.’

As well as the annual Cost of Defence work, Thomson ranged widely across the cash–kit–capability nexus. In Pay your money & take your pick, in 2003, he considered what sort of defence force Australia could afford by examining five alternative futures and differing levels of defence spending, ranging from a modest 1.3% of GDP up to a robust 2.5%.

At the cheaper end, Australia would have a force less capable than today’s but still able to undertake a credible range of tasks. The problem was that Australia’s relative military strength would erode as regional countries continued to modernise. With the top option, 2.5% of GDP would provide a power-projection capability built around two aircraft carriers and a much expanded army and more capable air force and navy, significantly boosting Australia’s standing as an ally and its role in the region.

To the question, ‘How much should Australia spend on defence?’, Thomson responded that there was no ‘right’ answer. Canberra made choices and trade-offs. Better a modest policy that worked and lasted than a more ambitious one that failed when the money ran out. Joined to that eternal economic judgement about the opportunity costs of government choices was a statement of the strategist’s creed:

Finally, in all strategic policy making, it is wise to maintain an intelligent pessimism. Lurid and implausible worst-case scenarios should not dominate our thinking, but it is important to bear in mind that strategic policy choices last a long time, and that large and unexpected changes happen surprisingly often. A strategic policy that cannot encompass inherently improbable events is likely to prove inadequate.

Australia’s ability to fund defence was a recurring topic—a discussion ranging from regional power shifts to Australia’s changing demographics. Assuming defence would account for 2% or 3% of Australia’s GDP by mid-century, Thomson’s 2004 calculation was a cash mountain of more than a trillion dollars, just to maintain current capabilities through to 2050:

To many commentators, the question of defence spending is all too simple. You work out what is required so that the Australian Defence Force … can fight and win in any credible circumstance and you simply pay the bill. And you do this irrespective of competing demands for health, education and prudent economic management. In this view, the government (and ultimately the electorate) retains a steady appetite for national security, no matter what the cost. If only defence planning was that simple.

The reality was a constant set of choices about affordability and risk management. The Thomson prediction was that economic needs would batter at Defence’s budget:

If demographics are destiny, our destiny is mixed. While we should be able to maintain a defence force like we have today—or even somewhat larger—out to 2050, our relative economic weight is set to decline in the decades ahead along with, more than likely, our strategic weight. This, by itself, is not an argument for spending more on defence. Just because we can afford to spend more on defence, does not mean we should; and just because other countries can afford to spend more on defence does not mean that they will.

In 2016, Thomson noted that since he wrote his first Cost of Defence in 2002, capital investment to modernise the force had driven the budget: investment had grown by 120%, operating costs by 46% and personnel costs by 39%. The ADF had become ‘a little larger, somewhat better managed, much better equipped, and a lot more expensive’.

Saying goodbye to ASPI in 2018, Thomson worried that multibillion-dollar defence projects were being contorted to ‘buy Australia’ and serve parochial politics:

In normal times, the creation of a boutique defence industrial complex in Australia would simply be wasteful. But these aren’t normal times. The strategic environment is deteriorating much more rapidly than current plans are strengthening the ADF. While the government focuses on the economically dubious goal of ‘creating jobs’ in defence industry, the gap between what the ADF can do and what it might be called upon to do grows by the day.

* Arthur Tange, quoted by Paul Dibb, ‘Defence policymaking’, in Peter J. Dean, Stephan Frühling and Brendan Taylor (eds), Australia’s defence: towards a new era, Melbourne University Press, 2014, p. 166.