The government has made its long-awaited decision on the first phase of LAND 400, Defence’s megaproject to acquire new armoured combat vehicles. And the even bigger decision on the future frigate is likely soon to follow.

The successful tenderer for the combat reconnaissance vehicle was Rheinmetall’s Boxer. It’s not clear yet why the government chose the Boxer over its competition, BAE’s AMV35. While the prime minister stated the number of jobs that would be created, he said that the selection was the result of a rigorous testing process that assessed the Boxer as ‘the most capable vehicle’.

Minister for Defence Industry Christopher Pyne was also at pains to state that the government went with Defence’s recommendation and that ‘politics played absolutely no part in the decision’. If that’s the case it was a remarkable decision, but one made for the right reasons.

It’s no secret that major defence capability decisions are being made in a defence industry environment that’s very different from when these projects were first developed. It can be amazing what a difference a few years can make.

The Abbott Coalition government came to power with a defence industry policy that was essentially indistinguishable from its broader industry policy. Subsidies were a bad thing, and just as the government wasn’t going to subsidise Australian industry to build cars, so it wasn’t going to pay extra to build military equipment in Australia. Defence’s investment plan was first and foremost about military capability, not nation building or supporting local industry.

Times (and prime ministers) have certainly changed, and changed quickly. The government released a new Defence Industry Policy Statement as part of the 2016 white paper. More recently, the government released the Defence Export Strategy aimed at boosting Australian industry’s share of the global market. Defence industry featured as a major source of ‘jobs and growth’ in Prime Minister Malcolm Turnbull’s election campaign.

By all accounts the big primes competing for the combat vehicles (and frigates) have gotten the government’s message that if they want to have a shot at winning, in addition to having a capable platform they also need well-developed Australian industry plans that maximise Australian industry participation in both the build and sustainment supply chains.

The contenders have thought hard about how to get Australian industry involved in the build and, perhaps more importantly, in the through life sustainment of the vessels and vehicles. If these plans provide a better understanding of the cost, schedule and risk implications of Australian industry participation, that’s a good thing.

Unfortunately other audiences have gotten other messages, which has led to rather undignified boosterism from state governments and local media. To the extent that their claims to be the most deserving rely on any arguments other than state-based parochialism, it’s that Australian content—whether dollars, jobs or steel—should be the ultimate determinant in the government’s selection.

That would be the worst approach to take. These decisions are too important to get wrong. The frigates and combat vehicles will provide the core of Australia’s maritime and land combat capability well into the second half of this century. For better or worse, the Australian Defence Force will have to live with the outcomes of these decisions for decades. Each decision must be made on the basis of which contender provides the best balance of capability, cost and risk. If, in the 2030s and 2040s, the government of the day needs to commit them to achieve its goals, the question of how much Australian steel they used will be irrelevant.

The reasons that Defence and subsequently the government chose Boxer over the AMV35 will take some time to emerge. By all accounts both contenders were viable candidates and a huge leap in all aspects of capability from the ASLAV vehicles that the project is replacing. From Ben Roberts-Smith’s recent comments, possibly on the basis of leaked selection trials, the Boxer performed better under blast testing, which is perhaps not surprising since the Boxer is bigger and heavier, carrying more armour. The Boxer is a more recent design and appears to have a more advanced suite of self-defence systems and sensors for all-round situational awareness.

All of this means that the Boxer is likely to be more expensive. Until now the government has stated that it would acquire 225 CRVs, but its Boxer announcement states that only 211 vehicles will be acquired. It may be that in its overall calculus of cost, capability and risk, the government chose quality over quantity. This would be quite consistent with Australia’s historical approach.

The project cost announced by the prime minister of $5.2 billion is beyond the upper end of the $4–5 billion budget in Defence’s Integrated Investment Program. It would be interesting to know whether Defence had to find money in other projects to top up LAND 400 to allow it to acquire sufficient vehicles.

Whatever the case, making a decision that isn’t squarely based on capability doesn’t only put Australia’s servicemen and women at risk. It also potentially denies the government itself of the capability it needs to meet its core responsibility of defending Australia.

So far it looks like the government is making its decisions for the right reasons.

PS. For those who have just arrived from Mars, the AMV35 was to be assembled in Victoria. The Boxer will be assembled in Queensland, with substantial input from Victorian businesses. After the initial disappointment wears off, Victoria’s $373.6 billion economy will likely survive.

Based on the volume of media coverage, the casual observer might be forgiven for thinking that Australia’s planned build-up of defence capital equipment has more to do with jobs and growth than national security. Yet, relative to the size of the investment, the amount of information available publicly on the economic impact of the proposed build-up is meagre. A number of stakeholders have recently attempted to fill a void in the availability of economic impact data, but with limited success—leaving reliable information on the industry ‘missing in action’.

Early this year, Minister for Defence Industry Christopher Pyne noted the defence industry’s contribution to Australia’s overall economic growth as measured in the National Accounts. From a 34% rise in the defence expenditure component of gross fixed capital formation (GFCF) in the December quarter 2016, the minister concluded that the industry had emerged as a ‘major reason’ for economic expansion across the economy as a whole measured by GDP.

Unfortunately, that assessment overlooks a number of important factors: the defence component of GFCF accounts for a small proportion of GDP; that component includes defence facility investment as well as the capital equipment investment normally associated with the definition of the defence (manufacturing) industry; the GFCF figure includes imported equipment; and quarterly figures are highly volatile, suggesting the appropriateness of trend data rather than the seasonally adjusted data that were used. The upshot is that the defence industry accounted for between less than 2% and 14% of the overall rise in GDP over the quarter—and the lower figure is a distinct possibility.

Defence’s naval shipbuilding plan then emerged to provide job estimates for the future submarine, future frigate, offshore patrol vessel and Pacific patrol boat projects. Covering nearly $95 billion of defence expenditure, the plan had the potential to plug a significant gap in the industry economic impact puzzle.

But the results are incomplete and inconsistent. While the economic benefits of the projects are noted, no mention is made of their potential economic costs—not even the costs associated with the government having to pay for the vessels by raising taxes, reducing expenditure elsewhere or borrowing more money. And job numbers for each project are calculated using different methodologies over different time frames, which effectively precludes them being combined to give a useful sectoral view. To what degree the results could, or should, comply with new government economic impact reporting requirements under the 2017 Commonwealth Procurement Rules is unclear.

An October report focusing on naval shipbuilding’s economic impact on South Australia added only marginally to the knowledge base. Here again the results are difficult to assess: no, more illuminating, national data are provided; economic benefits are included but economic costs are not; shipbuilding figures are combined with ship sustainment figures, making the individual contribution of building difficult to determine; and claims that shipbuilding and sustainment in South Australia will create new forms of economic activity equal to the state’s mining industry are proffered in the absence of important contextual information showing that mining accounts for only around 1% of statewide employment.

Outside the naval shipbuilding arena, an earlier economic impact report commissioned by Defence examined the effects of Australian industry’s participation in the Joint Strike Fighter global supply chain program. As the posterchild for the defence industry’s role in the development of advanced manufacturing in Australia, the program holds a position of special interest from a jobs and growth perspective.

To its credit, the study considers economic costs as well as economic benefits. However, as ASPI has already observed, the report’s estimates of economic impact are difficult to reconcile. The modelling appears to be underpinned by a somewhat unusual assumption: even after sales contracts for the JSF expire, the people those contracts help to employ can be retained, presumably as a result of the companies involved gaining enough additional capability through the JSF program to attract a completely new clientele.

State governments have over a number of years attempted to estimate what the defence industry might add to their economies. New South Wales, Victoria, South Australia and Western Australia have all generated relevant reports. Nonetheless, the scope of data in those documents varies enormously and not all states and territories appear to have attempted an industry profile. Moreover, the reports don’t provide all-important insights into Defence’s future procurement plans and appear to rely to at least some degree on Australian Bureau of Statistics data, which isn’t structured to reflect the special characteristics of defence manufacturing. Boeing recently commissioned an economic impact study of its activities around Australia. However, with a single-company focus, the study’s contribution to broader public policy is limited.

An outstanding feature of Defence investment in industry is that even the largest investment projects tend to have a small relative economic impact when measured on a national basis or even in terms of the economies of most states and territories. However, their effects at a regional level can be a lot more significant. Ironically, the attempts to measure economic impact noted above pay little, if any, attention to the regional dimension.

With the federal government committed to spending 2% of GDP on defence over the next decade, Australia’s naval shipbuilding sector is set to undergo a renaissance that will drive the development of a new wave of skills and jobs, while allowing hundreds of domestic companies to tap into lucrative and sustainable global supply chains.

While some have forecast the demise of manufacturing in Australia, this commitment to building a sustainable shipbuilding industry will see supply and support facilities ramp up right around the country. It’s an opportunity for Australia to build a sustainable, world-class export industry capitalising on the government’s investment in shipbuilding.

We are living, unfortunately, in an increasingly unstable environment. Governments around the world are seeking to better equip their militaries to provide national security to their populations. Australia is well placed, as a respected middle power with solid relationships around the globe, to generate new export opportunities as it builds its own military capability.

The minister for defence industry, Christopher Pyne, has identified the Middle East as one area where Australian companies could pick up lucrative contracts.

There’s no reason not to also look closer to home, to the Asia–Pacific region where governments are seeking to build their defences amid growing regional instability. With close neighbours, such as Indonesia, the government has taken the fight to the scourge of people smuggling, successfully disrupting an evil trade. Minor war vessels have played a key role.

As well, the rate of piracy and maritime crime in Southeast Asia continues to be a concern. Maritime intelligence company Dryad, for example, in its most recent analysis posted in February 2017, reported that these activities in the waters off the southern Philippines are posing a significant threat to seafarers.

The $3 billion offshore patrol vessel program, in which Lürssen is a shortlisted bidder, provides a further opportunity for Australia to play an even stronger role in building regional capability in this crucial area.

In terms of strengthening Australia’s naval shipbuilding capacity, positive signs are already emerging. Global giant Thales has just announced plans to revitalise the Carrington Marine Services Precinct at the Port of Newcastle, creating an estimated 70 jobs in the development phase alone. This is great news for the Hunter Valley and a small but tangible sign of a growing confidence in a sustainable shipbuilding sector.

The major catalyst for this future prosperity is the federal government’s $90-billion-plus investment in new surface warships and submarines. This has generated global interest in the shipbuilding world, considering both the immediate benefits and longer term prospects in the region.

The opportunity to develop a credible, innovative and sustainable shipbuilding industry in Australia—which can eventually compete for export contracts against established incumbents such as France, Spain, Italy and South Korea—is very much in the sights of both the government and foreign shipbuilders. There’s no reason this can’t be achieved, but the scale of the challenge shouldn’t be underestimated.

The naval shipbuilding plan is an excellent starting point, but, given the scale of the undertaking, it’s time to establish guiding principles around which governments, industry and other stakeholders, such as Australia’s allies, can rally. Mistakes of the past must be recognised and avoided, along with the peaks and troughs that have contributed to shipbuilding’s so-called valley of death.

As a middle power, Australia should embrace a competitive naval shipbuilding sector that avoids a model based on having one key customer (the government) and a small oligopoly of shipbuilders. A vibrant naval shipbuilding sector must be underpinned by competition and free enterprise, and an export industry is the key to making that happen.

The Department of Defence, which is overseeing the implementation of the shipbuilding plan, must ensure that excellence and innovation in design and shipbuilding processes are promoted to demonstrate that Australia stands with the world’s best.

It will be critical to invest in shipbuilding skills, and the government has made an important start with the announcement of the Naval Shipbuilding College. The college will be headquartered in Adelaide but will provide education and training opportunities across the country. This is critical.

Australia needs to build its skills base right around the nation, not just in Adelaide and Perth, even though those cities will underpin much of the initial phase of the program. Other regional areas and cities—including Far North Queensland, Darwin, Melbourne, and regional NSW, Victoria and Tasmania—must be able to leverage the numerous opportunities that will flow through the design and build phases and then through the ongoing sustainment programs.

With most of the 12 offshore patrol vessels to be stationed at Darwin, a multimillion-dollar investment in highly skilled maintenance and other jobs will be required to support them. This will include engineering and other trades necessary to support a fleet of world-class vessels above and beyond the support that Darwin-based industry already provides. It will also offer new opportunities for Darwin-based small and medium-sized enterprises to provide a range of services with the potential to tap into global supply chains.

The opportunities are endless for Australia to work with its allies and some of the world’s leading shipbuilders and designers to develop an exciting export industry.

With careful nurturing and the right investment in skills and training, Australia can create a sustainable naval shipbuilding industry that will, in decades to come, stand as a testament to the forward thinking of this generation.

In March 2017, the Minister for Defence Industry told ABC radio that ‘We know the defence industry is driving the economy.’ He backed up that claim by referring to the just-released National Accounts for the December quarter, saying, ‘it showed that defence spending had increased by 15.2 per cent over the year and 34 per cent in that quarter alone and was showing up as a major reason for the increase in growth’.

Of course, defence spending hasn’t increased by anything like either of those figures. What’s probably happened is that one of his staff noticed the line in the ABS release that says, ‘public investment increased 7.7% during the quarter driven by Defence (34.2%) and….’.

The statisticians weren’t talking about defence spending, but rather the impact of defence investment on ‘fixed capital formation’. Checking through the ABS spreadsheets, it turns out that defence fixed capital formation for the December quarter was 15.1% higher than the corresponding figure a year before. So, almost certainly, the Minister was referring to defence fixed capital formation.

Now if you take defence-related fixed capital formation to be a proxy for Australian defence industry (I’ll explain later why it’s not) the Minister’s claim begins to make sense. Crunching the numbers, defence-related fixed capital formation contributed 0.15% to the quarterly GDP growth of 1.1%. But that doesn’t mean that defence industry was ‘a major reason for the increase in [economic] growth’. To understand why, we need to look at how GDP is calculated in the National Accounts:

GDP = Final Consumption Expenditure + Gross Fixed Capital Formation + Exports of goods and services – Imports of goods and services

Final Consumption Expenditure is the value of what’s purchased for consumption (food, clothing, medical services, etc.). Gross Fixed Capital Formation is the value asset purchases (building, railways, fighter aircraft, etc.).

The ABS provide figures for defence final consumption and fixed capital formation (but not for exports and imports). Figure 1 shows the results going back to 1959, seasonally adjusted. Not surprisingly, the total mirrors the share of GDP spent by the government on defence. Defence final consumption is large because it includes personnel costs, as well as items such as rations, fuel, uniforms, and equipment maintenance.

Figure 1: Defence related contributions to GDP in the national accounts, 1959–2016

Note also that fixed capital formation has been growing as a share of GDP since at least the early 1970s. Fixed capital formation includes the construction of defence facilities and the purchase of new equipment. It’s been growing because (1) increases to the price of military equipment have outpaced inflation, and (2) the ADF has been becoming more capital intensive (including through the post-2000 defence build-up).

So far, no surprises: you spend a couple of percent of GDP on defence and it shows up as a couple of percent of GDP in the National Accounts. You’d worry if that weren’t the case.

But what about defence industry ‘driving the economy’. There are two problems with Minister’s statement.

First, the quarterly figures for defence fixed capital formation are too volatile to deduce anything from either a quarterly or annual quarter-to-quarter figure. The figures for the past eight quarters (working backwards) were: 34.2%, -28.6%, 30.0%, -7.4%, 32.2%, -35.3%, 29.6% and -5.1%. You can’t sensibly extract a trend from such volatile data over a brief time—it’s like looking for evidence of global warming by comparing today’s temperature with yesterday’s.

If you want to understand the economic importance of defence fixed capital, it’s the long-term share of GDP that matters. On that basis, shown in the Figure 2, there’s no short-term trend to be seen, and the long-term trend is an increase of a mere one-hundredth of a one-percent of GDP per annum.

Figure 2: Defence-related fixed capital formation as a share of GDP, 1959 to 2016

Second, as already mentioned, defence-related fixed capital formation is a poor proxy for defence industry. To start with, it includes the value of imported defence equipment (which is why the equation for GDP subtracts imports). It’s entirely possible that the 34.2% jump referred to by the Minister came from a surge in defence imports. In recent years, less than 40% of Defence’s procurement budget has been spent in Australia. Once that’s considered, the 0.5% of GDP attributed to defence fixed capital formation falls to 0.2% of GDP. And, yes, defence exports add a further boost, but it’s too small to worry about in the national accounts. In addition, defence-related fixed capital formation includes facilities construction, which is both substantial ($1.5 billion this year) and entirely unrelated to defence industry.

A focus on fixed capital formation also ignores the substantial contribution that defence industry makes to sustaining ADF capabilities. Materiel sustainment resulted in around $4 billion of local expenditure in 2015–16, compared to only $2.4 billion on equipment purchases. But the money spent on local sustainment was always going to happen, irrespective of the government’s ‘buy Australian’ defence procurement policy. The tyranny of distance means there’s usually no practical alternative to supporting defence assets locally.

To recap, far from ‘driving the economy’, defence industry contributes modestly to the national accounts. That’s to be expected; the National Accounts are roughly a case of what you put in, you get out. Moreover, the quoted growth of 34% in fixed capital formation comes from data that’s far too volatile to sensibly extract short-term trends—even if that weren’t the case, defence-related fixed capital formation is a decidedly poor proxy for defence industry.

With so much emphasis on generating jobs and growth from defence production, you’d think that the government would be getting the best economic analysis available to guide its decisions. Yet, as this example shows, that’s not the case. I wonder whether the economic analysis underpinning the looming wave of ‘nation building’ defence mega-projects is any better.

This is an extract from the forthcoming ASPI Defence Budget Brief.

The unprecedented focus on Australia’s defence industry during the current federal election campaign has highlighted the role the industry can play in developing sovereign capability and industrial self-reliance in key areas of defence procurement.

In equal measure defence industry is now being recognised as a valuable contributor to both jobs and capability.  

The Defence Industry Policy Statement which accompanied the Defence White Paper stated that, for the first time, the Government has formally recognised the vital role of Australian defence industry as a discrete, fundamental input to capability. The Defence organisation will now fully consider both industrial capabilities and the capacity of Australian businesses to deliver to Defence.

This formal recognition has been welcomed across industry as has the acknowledgement that a formal framework is required to identify and manage those sovereign industrial capabilities to be maintained and supported by Defence.

The new arrangements will be closely monitored by industry and it would appear that the first test for the new approach will be for the selection of a combat system integrator for the future submarine.

Under the old regime support of the Collins-class submarine combat system was deemed to have been a priority industry capability. Whether an analogous arrangement will be secured for the integration and sustainment on the same AN/BYG-1 combat system on the RAN’s future submarine will depend very much on this important selection.

Strong guidance for this decision was provided in the Future Submarine Industry Skills Plan produced by the Department of Defence in 2013.

Amongst other things, the report measured the strength of Australia’s combat system workforce and found that considerable experience and skill resided in the people who commenced the Air Warfare Destroyer combat system integration task in 2005—the same core team that had previously worked on the Collins replacement combat system. Importantly, it stated:

‘The benefit of having an established proven team is much greater than generating a new team of experienced people. The team comes with people who know each other—teamwork and proven tools and processes.’

The report noted that, had the AWD task been undertaken by a newly formed team, ‘it would have required more time and budget because of low productivity and time spent by the team working out roles and dependencies.’ For the purposes of the future submarine the report made the strong conclusion that it takes time to grow individual skills and more time to grow proficient teams.

It’s no coincidence that one team for the future submarine integration role offers not only the largest combat system workforce in Australia and the promise of 700 Australian jobs, but nominated key personnel with more than 150 combined years of in-country Australian submarine combat system integration experience. By any measure this represents the basis for a sovereign submarine combat system integration capability for Australia.

After making such a strong statement about the importance of blue collar jobs to the city of Adelaide it would be incongruous to rely on a fly-in fly-out workforce to provide the sovereign, high end systems integration roles Australia requires.

The forthcoming decision on the combat system integrator for the future submarine therefore offers a genuine opportunity for Defence to demonstrate the strength of its commitment to a truly sovereign Australian defence industry.