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Finding a balance between encouraging Australia’s domestic manufacturing to ensure supply-chain security for critical sectors and not violating free-trade agreements by introducing tariffs and subsidies for ‘strategic industries’ will be a tough task for the government.

As a member of the National COVID-19 Coordination Commission, former Dow Chemical chief Andrew Liveris is tasked with developing a long-term strategy to retool Australian manufacturing. Liveris says that, in Australia, support and tax credits for research and development have basically disappeared while other countries have massive credits in place to encourage innovation and scalability. He highlights health, defence and cyber as vital sectors of the economy.

Defence faces significant risks in any disruption to supply chains. The planned capital investment budget for 2019–20 is a shade under $12 billion. Chunks of this will be spent in Australia, including building the army’s Hawkei protected mobility vehicle and Attack-class submarines, but most of those supply chains reach directly back to the US. Equipment delivery and munitions are secure in the interim, but the pandemic highlights the paucity of defence equipment manufactured here.

The ‘onshoring’ of defence manufacturing isn’t realistic for Australia because there’s not much we can build without major structural readjustments to defence policy and the economy.

While the political, military and intelligence relationship with the US is close, there are different rules in play for the US defence industry. The US approach has always been America first. That’s no surprise; Australian dollars can’t compete. US Air Force funding for 2020 is US$204.8 billion ($294 billion), for example. While Australia spends around $105 million per day on all of Defence, the USAF alone spends eight times that amount.

Programs like the MQ-4C Triton drone, which may have a production ‘pause’ for two years, show how little say Australia has in the production and development of high-end weapon systems when the manufacturing base is in the US. We will rely on the US and to a lesser extent Europe for major systems for a long time to come.

Instead, it would be smarter for us to develop technology and design solutions that maximise human performance and information advantages. Some of these defence technologies in robotics, artificial intelligence and precision engineering could have dual uses in agriculture, education or health.

Rather than building heavy equipment, we need to create big ideas and turn them into physical systems. This was Liveris’s approach in the US, where he led the Advanced Manufacturing Partnership involving government, industry and academia.

Currently, investment here is split between the Next Generation Technologies Fund and the Defence Innovation Hub. The fund and the hub are allocated $73 million and $64 million, respectively, per year. Both the fund and hub are focused on small to medium-sized enterprises and provide limited grant allocation. For larger businesses, any R&D money comes out of their profits. Cost allowances for R&D are available only after a contract is awarded, putting all the development risk onto the contractor.

While tax concessions are available, R&D investment is a deduction from earnings before interest, taxes, depreciation and amortisation that only becomes available at the conclusion of a financial year and is further delayed through the payment claims system.

Australian defence industry must invest in R&D and avoid becoming an integration, assembly and sustainment provider.

Unfortunately, Defence retains a central-planning mindset of picking winners instead of taking a collaborative approach to solving problems. This limits the scope of innovation to developing solutions already defined by Defence and avoids engaging with or incubating emerging and disruptive technologies. It’s a sure-fire way to build the next Leyland P-76.

More than a third of Australia’s federal R&D budget goes through tax incentives to the finance, mining and technology sectors. The opposite approach is applied in Israel, where the Innovation Authority is funded to provide solutions to challenges facing the ‘Israeli innovation ecosystem’ and support industry R&D.

The success stories in Australian defence industry typify the clever application of ideas and human capital. Boeing Australia initially developed the ‘loyal wingman’ drone as an internal project. It was able to do so because the company has deep pockets and because it could draw on a local team of innovative problem-solvers who understood the unique characteristics of Australia’s strategic environment.

The fourth industrial revolution provides multiple avenues for disruptive technology to emerge in artificial intelligence, computer-aided decision-making and autonomous and teamed systems. Mastering these technologies will be less resource intensive than manufacturing physical equipment and systems but will require a similar investment in capital.

The answer to defence supply-chain disruption isn’t necessarily building equipment here. And it certainly doesn’t lie in rebuilding tariff walls pulled down in the 1980 and 1990s. The answer must come from using our human and information advantages to enable industry and academia to maximise Australia’s security. The key to this will be effective Australian R&D.

The Covid-19 pandemic has exposed weaknesses in Australia’s supply chains and manufacturing capacity and prompted a re-examination of the concept of sovereignty more broadly.

One prominent contention is that globalisation has been steadily eroding Australia’s manufacturing capability and that this trend needs to be reversed. Some commentators’ calls for government-mandated manufacturing are almost socialist in nature. Those on the opposing end of the spectrum argue for a return to the global market as soon as possible because free trade has underpinned our standard of living and the government’s ability to fund essential services.

Rather than engage in binary debates, the government must focus on making decisions in the best interests of Australians, notwithstanding what other nations do. This definition of sovereignty requires us to assess what constitutes an unacceptable risk of systemic failure in critical facets of our society, economy and governance structures from external factors. While Australia has a recognised risk-management standard, we need to look at areas such as aviation, engineering and defence for insights into how we should approach these assessments.

As a former military experimental test pilot, I dealt with risk on a regular basis. A key tool was a systems-engineering process known as ‘failure mode effects and criticality analysis’, or FMECA. That involves analysing all the component parts and systems that keep us safely airborne and identifying which ones could fail and which failures would be most likely to prevent a safe landing.

When practicable, the design can be altered to eliminate the failure mode in critical systems. If that’s not feasible, an accident causation model is applied to reduce the probability of failure and to mitigate the consequences of a failure to an acceptable level.

The pandemic has highlighted that we haven’t applied these principles to the range of processes, systems and interactions that underpin our government’s ability to make decisions that are in the best interests of Australians. We haven’t systemically defined and protected our sovereignty.

The public debate on liquid fuel security is the closest we’ve come in recent years to attempting this. That problem hasn’t been resolved, in part, because of the unfounded belief within the bureaucracy and the private sector that market forces will always ensure that someone, somewhere will be able to supply what we need, when we need it.

While Covid-19 has not yet disrupted fuel supplies, it has demonstrated that the established rules between nations rapidly become subservient to national interests. In light of this, Australia needs to revisit the fuel issue and to apply a FMECA standard to many other systems. These include the healthcare, finance, food and security systems—those we rely on to remain a functioning, developed nation.

The defence industry policy statement published in 2016 is an example of how such an analysis could be implemented through government policy and procurement. A 2015 report by parliament’s Joint Standing Committee on Foreign Affairs, Defence and Trade analysed how Defence could engage Australia’s private sector industrial base to increase sovereign control of military capability and lower the cost of maintaining technology. The report formed the basis of the policy statement, which initiated measures to develop a sovereign defence-industry capability.

While its implementation has not been entirely what the parliamentary committee envisaged, the defence industry policy statement has shown that the government has a range of options to reduce risk. These include co-investment in research and development, controlling access to intellectual property, underwriting manufacturing capacity through offtake agreements, and funding industry to create and sustain a capability that can be scaled up as demand requires.

Some facilities are government-owned and contractor-operated, while others involve long-term partnering arrangements with a commercial entity.

When Australia uses equipment produced overseas, other measures can mitigate potential failures in supply chains. These include investing to sustain things like the engineering ability to make decisions about issues such as material fatigue and to certify repairs, and Australian-based repair and overhaul facilities.

If a FMECA had been applied to health, for example, the government might have viewed differently the closure in 2015 of Australia’s only commercial facility manufacturing spunbond, which is the critical component in surgical masks. The plant in Albury was closed because it couldn’t compete on price with offshore providers.

During the pandemic, mask manufacturers have purchased supplies from overseas but foreign governments have blocked their export because of their own domestic requirements. The bidding wars to source protective equipment and the consequences of global shortages for health workers would suggest that some intervention in 2015 would have been prudent.

That could have been done by co-investing in better manufacturing processes, providing funding for research and development for an alternative to spunbond, or even entering into an offtake agreement to keep the plant open and capable of scaling up. That would have allowed the global market to provide the bulk of our business-as-usual needs at a lower price while retaining a domestic capability for times of crisis.

Keeping pace with software development is another key issue in sovereign capabilities. In the past, Australia has established weapons-system support facilities to enable, for example, control over aspects of mission-critical software in aircraft like the F/A-18 Hornet and F-111.

There’s also much we can learn from nations such as Finland, which has a National Emergency Supply Agency that coordinates reserves of a broad range of commodities, including medical supplies, oil, grains, agricultural tools and raw materials.

Covid-19 has sounded a national wake-up call that ceding sovereignty to the free market presents an unacceptable risk in critical areas.

The answer is not to nationalise manufacturing, which history has shown is unproductive. Australia must apply engineering principles to identify, quantify and manage systemic risk to the security of lives and livelihoods. This ongoing investment to find and maintain the optimal blend of global connectivity and self-reliance would form the basis of an Australian national sovereignty strategy.

The latest salvo in the national debate about how best to spread the risks and benefits of the $300-billion naval shipbuilding plan is whether full-cycle docking of the Collins-class submarines should move from South Australia to Western Australia. It’s an important decision.

The Collins fleet is based in Perth. Although the boats were built by ASC in Adelaide, their ongoing sustainment involves four-yearly mid-cycle dockings that take place at HMAS Stirling and the Henderson shipyard in Western Australia. ASC has a total workforce of around 2,200 with around 280 positions in WA to do routine and mid-cycle sustainment work.

Major full-cycle dockings are required every eight to 10 years. They take two years to complete and can involve cutting open the submarine for a ground–up ‘nuts and bolts’ rebuild of hardware and systems. They are currently returned to the manufacturer, ASC at its Adelaide shipyard, where a highly skilled workforce reinvents each submarine.

WA has produced, and selectively released, reports which claim it’s in the ‘national interest’ to move the full-cycle dockings to Perth. There are hidden benefits for WA in its proposal. To cover the capability gap between the Collins-class and Attack-class fleets, there’s a multibillion-dollar plan to extend the life of possibly all six of the Collins submarines. If full-cycle dockings move to Perth, it’s probable the life-of-type extension would take place there too; and there’s more.

As ASPI’s Marcus Hellyer has noted, the government is yet to decide how the new Attack-class submarines will be sustained. If ASC is given that job, and if the company has in effect relocated to WA to support full-cycle dockings for Collins, then it’s highly likely that the 12 new submarines will also be sustained in WA. For every $1 billion spent building submarines, it’s generally accepted that around $2 to $3 billion is spent on sustainment. Defence is looking into the idea.

As luck would have it, Defence Minister Linda Reynolds, Defence Industry Minister Melissa Price and Finance Minister Mathias Corman all hail from WA. Attorney-General Christian Porter, another West Australian, is on the seven-member National Security Committee of Cabinet, which will make the final decision. No South Australians anywhere to be seen. The credibility of the full-cycle docking decision, and of the ministers, hinges on an outcome which is genuinely in the national interest, not just the political interest of the decision-makers. The process will be closely scrutinised.

Claims that assembling the skilled workforce, infrastructure and industry support required to both build and sustain submarines is beyond South Australia need to be balanced against similar competing pressures in WA caused by its existing fleet support and sustainment commitments and the prescient demands of recurring mining booms which tend to vacuum up skilled workers and resources wherever they can be found. SA needs to produce its own research to argue its case to ensure Defence is fully informed of the counterarguments and facts before the ‘Defence State’ misses the proverbial boat!

There is an alternative approach. In January 2017, I took to cabinet in SA recommendations from the Defence SA Advisory Board chaired by former defence force chief Angus Houston proposing that a national shipbuilding authority be established. The cabinet submission was supported by an authoritative 71-page report. We argued that the Naval Shipbuilding Advisory Board had been ineffective and that a more executive and enterprise focused body was needed to implement a coordinated national approach to the entire construction and sustainment cycle.

The nation’s aim must be to lift the Australian naval enterprise from a base level of maturity characterised by individual project decisions and an immature sovereign industrial capability to a dynamic best-practice model with minimal government control and ownership which looks at the entire task and is industry led. The report outlined a sustainable commercial structure for the next 50 years which optimised value for money and minimised risk with the entire shipbuilding enterprise at its core, not individual projects.

The proposal called for the creation of a national shipbuilding authority to report directly to the prime minister with an enterprise- and industry-focused executive board, a CEO and the authority to coordinate the national effort across government portfolios and agencies, across industry and the union movement, and across the higher education and vocational education sectors. The goal proposed was to ensure the effective delivery of both the operational and defence industrial capabilities the nation seeks. This would require a national balancing of the demands of construction, mid-cycle sustainment, full-cycle sustainment and fleet support across all ship types and programs with the nation’s workforce, and industrial and infrastructure bases for best effect.

Surely it’s better to be matching the entire national shipbuilding task with the whole of the nation’s capability to deliver, rather than to have the states arguing with the Commonwealth about who will do what with a particular part of a particular program. Unfortunately, an election and a change of government in SA followed this cabinet deliberation. The work seems to have sunk without a trace.

The social licence to spend such an enormous amount of taxpayers’ money on building warships depends on proving to Australians that the result will both defend the nation and strengthen its economy. A national shipbuilding authority could help deliver that outcome. The SA government would be well advised to refloat the report, release it for public discussion and take it to Canberra and to the Council of Australian Governments.

In the midst of the discussion about the Royal Australian Navy’s future frigate and submarine programs, it’s important to acknowledge the significance of their continuous nature and to remember that they have design and building elements. While the qualities of the Hunter-class frigates and Attack-class submarines are significant in and of themselves, they must be understood as part of an overall national endeavour.

Australia has the critical mass to maintain a continuous program of warship design and construction and, as a result, can obtain greater value for money. In this two-part series, I’ll look at the opportunities to get better value for money and suggest a way to understand that critical mass.

At first, it might appear counterintuitive to imagine that we’re going to get better value for money by maintaining a continuous building program; the sums of money to be spent are very large. However, much of the commentary has been focused on what can be easily seen and understood—the cost and the schedule. The cumulative expenditure on warship-building over multiple decades is easily reduced to a single, eye-catching number. However, as all economists know, value is a function of both the benefit derived and the cost. And, as all public servants adhering to the Public Governance, Performance and Accountability Act know, value for money is one of the most important principles for the expenditure of public funds.

So how does Australia get better value for money? By obtaining greater benefit, and greater military capability, dollar for dollar, from continuous warship-building than from the stop–start methods of the past four or five decades. The greater benefit—beyond the benefits that come from direct ownership and operation of the vessels and systems themselves—is found in at least three areas.

First, at a strategic level, we will be more agile. The maritime component of our national military capabilities can be more quickly and efficiently scaled and shaped according to our strategic circumstances. This gives us greater strategic weight, which will be taken into consideration by allies, neighbours, partners and potential adversaries alike.

As the continuous program of design and construction reaches maturity (for submarines, frigates and patrol vessels), the government will have more options to respond to changes or opportunities in our strategic environment. Essentially, our national OODA loop (John Boyd’s elegant ‘Observe, Orient, Decide, Act’ description of command decision-making) will be much tighter, making us a more valuable ally and our defence force more formidable. Significantly, the options can be tailored to the change in environment (submarines, frigates and patrol vessels provide different levels and types of capability), and any adjustments can have a prompt impact on the strategic environment, because an active production line can adapt quickly.

Second, a continuous design and construction program will give us vessels that are a closer match to what we actually need. We’ll be able to innovate to get more of what is valuable to us and less of what is not, and to be fast followers or leaders of technology and practice. This highlights that the continuous production must also include a constant design effort, utilising batch-build and spiral-upgrade concepts where appropriate. Importantly, we’ll be able to vary the design and construction parameters over time as our environment and requirements evolve. We won’t have to stay bound to a contracted solution which made sense a decade ago.

At an individual level, most of the design decisions seem quite simple, albeit significant. For example, the accommodation spaces in our ships will be designed to suit an all-volunteer, mixed-gender crew. That’s crucial to the Australian navy because of the time and money involved in training people, as well as the need to attract and retain capable and skilled personnel.

It’s also important to remember that warships are sophisticated ‘systems of systems’, and not every system is wholly contained within the vessel. In an integrated Australian Defence Force, our vessels must be able to operate as part of a joint force. This affects almost everything we do, from air defence, to surface and anti-submarine warfare, to logistic, personnel and medical systems. There’s value for money in understanding and incorporating these Australian requirements from the start, and not retrofitting them at considerable time and cost (not to mention increased technical complexity and risk of delay) into a vessel designed for another navy.

The third benefit is found outside of the areas usually considered when assessing shipbuilding. Once the continuous design and construction program reaches maturity, the warship production cycle will be more reliable and accurately predictable. This will assist the navy and defence industry because it will enable other parts of the system to be optimised—for example, the crew of a new vessel can be formed at the optimal time to take over that vessel, reducing personnel inefficiencies and time lost because a ship isn’t delivered on schedule.

It will be important to document and, where possible, cost these benefits to provide a transparent demonstration of the compelling value-for-money case for a continuous warship-building program.

Other efficiencies are likely to accrue as we move past the start-up phase, such as those that come from experience and learning. While these are essential to the overall value for money of the program, it’s important to remember they’re an adjustment to the cost of the program. The great value-for-money benefit to be gained isn’t so much about the cost (as important as that is); it’s more about the utility the nation obtains from acquiring its warships in this way.

The second criterion for a continuous ship design and building program, critical mass, will be discussed in part 2.

The Australian government is close to deciding which of the three big foreign companies wins the $35 billion contract to build nine antisubmarine warfare frigates for the Navy. We examine the SEA 5000 Future Frigate program’s three objectives in our new ASPI Strategic Insights paper, The next big grey thing—choosing Australia’s future frigate, written with James Mugg.

We should care about the future frigate decision for two reasons. It’s important that the Navy gets the best capability to deal with the proliferating number of quiet, lethal, modern submarines in our region. But as important in a different way, who wins the project and how they work with Australian firms will define our shipbuilding industry for decades.

Defence projects have always been big, but in recent years they’ve moved from being elephant-sized to whale-sized megafauna. If the future submarines program (some $50 billion in acquisition and maybe another $115 billion or so in sustainment) is the blue whale of the pack, then the future frigate program is the next biggest—the lesser-known but huge finback whale. It’s acquisition cost is some $35 billion and so its sustainment is likely to be in the order of $80 billion (according to indicative cost proportions in the government’s naval shipbuilding plan).

Like megafauna, they’re also slow moving. The first frigate is expected to enter service sometime in the late 2020s—after being delivered to Defence sometime around 2027 or 2028—and the last of the nine ships will probably finish production in the early 2040s.

It’s a slow program partly because 6,000–7,000‑tonne warships are complex integrated electro-mechanical devices that take time to build, but also because slow production is what the government’s new continuous build strategy proposes, so that there’s a continuous flow of work—not starts and stops that might disturb the Australian workforce. This is what a sovereign shipbuilding capability as proposed means—you get ships at the rate that keeps industry happy, not the rate that the Navy might need them to turn up.

So, which ship is best, and who might provide the government with the best industrial strategy for delivering frigates on time and on budget while creating a sustainable long-term Australian shipbuilding industry?

The bad news is that we can’t tell you who will win. The good news is that there are good reasons we can’t tell you.  Defence has kept its evaluation of the three tenderers between it and government (as it’s meant to). Furthermore, from the information ASPI has about the three ships, all three do what the Navy wants pretty well, so there’s probably no clear winner just on capability.

BAE may well have read the wind on Aussie industry matters and so have places in their plan for the two Aussie icons—ASC and Austal. More importantly, though, when it comes to not paying the 30–40% premium that the RAND Corporation said Australian governments traditionally pay for building ships here, the Australian government has the opportunity to use its $35 billion leverage to get the Brits to give Australian firms a hefty share of all Type 26 production globally. This includes the Royal Navy’s eight‑ship program and the Canadian 15‑ship program if BAE wins that. The UK needs sales and partnerships like this one in its post-Brexit world, so the government could drive a hard bargain on intellectual property and international production.

Navantia, wholly owned by the Spanish government, is building military vessels for Australia, Spain, NATO clients and potentially the Canadians—perhaps even the US Navy (if Navantia wins the 20‑ship FFG(X) program in partnership with Bath Iron Works). As with BAE, the Australian government has a major opportunity to open up Navantia’s global design and production supply chain to Australian firms. Australia’s decision comes ahead of both Canada’s and the US Navy’s, so a win by Navantia here would give them momentum they need.

Fincantieri hasn’t built a ship here in Australia, so Australian industry and government would have to get to know that organisation and its practices. On the plus side, Fincantieri is a truly global shipbuilder, with a wide commercial and military ship market and production chain. Its frigate is in the US Navy FFG(X) competition. The Australian government could expect to be able to drive a deal in intellectual property and supply chain participation that sees Australian firms contributing to Fincantieri ships, whether commercial or military, across its 20‑country footprint and international market.

Which will the government choose? Emotionally, the Brit option might just feel right in this nasty post-globalisation world where allies and partners who mean it are hard to come by. Its glossy brochure design is also brand new, so there’s nothing to dislike about its performance. But the entire history of complex projects shows that there are reasons to be wary of signing up to a new design with all the wrinkles, twists and problems they have. If that’s too daunting, and the government prefers low project risk and the best chance of getting a ship on budget built here in Australia, they might go with Navantia. It might also be able to drive the lowest price too.

But if the government is thinking strategically about naval shipbuilding as an enterprise over decades, and thinking about what $35 billion of leverage might achieve, then they may take Fincantieri. It’s offering a hugely capable modern ship, and it also provides the widest opportunities for Australian firms to be export partners with a successful global commercial and military shipbuilding firm. If the government is ruthless in its negotiations, it might well be worth the growing pains of getting to know Fincantieri.

Regardless of which ship is chosen, the members of the National Security Committee of Cabinet need to avoid treating this decision like any other defence project decision. Big project decisions in defence have historically evaluated offers against capability, schedule and cost, with the risks in each of those buckets being compared. That has to happen this time as well, but there’s also a bigger picture.

The unique and difficult part of this decision comes from the unique opportunity that Australia has in spending $35 billion on nine frigates. In a world of declining Western naval fleets, that’s a huge business opportunity for the firm that wins it (and for its home country’s government).

That unique leverage is the way that the Australian government can use the frigate program to create a sustainable Australian shipbuilding industry. Not by insisting on local incumbents getting a workshare. Not by focusing on Australian industry targets within the contracts. The real new opportunity here for Defence and government is to get Australian firms large chunks of the winning company’s international supply and production chains—for all the ships they build around the world. But it’s a balancing act—compromising too much on Australia’s future naval capability for a possible future industry return isn’t the smartest thing to do in troubled times.

BAE Systems, Navantia and Fincantieri haven’t become successful ship exporters because they give away production work and share intellectual property beyond narrow projects. They’ll be perfectly comfortable with a decision that focuses just on the Australian ships and who the local partners are. They’ll be happy with airy words about knowledge transfer so that, in a distant future that may never eventuate, Australian builders sell whole ships internationally.

They’ll be happy because all that will miss the bigger industrial opportunity Australia has to insist that Australian firms get business in the winning company’s entire international production order book starting now.

Success for Australia will take ruthless leadership from ministers and equally ruthless commercial negotiation with whichever firm wins the contract.