2% – can we, should we, will we?

The incoming government’s promise to boost defence spending to 2% of GDP within a decade has attracted a lot of commentary, including here, here and here on The Strategist. And well it should. It’s a massive promise that, if kept, will reverse a sixty year downward trend in the share of the Australian economy allocated to defence. (See graph below.)

Three questions follow naturally: is it possible, is it necessary and is it really going to happen? I offer some thoughts on each below.

Is it possible for Australia to spend 2% of GDP on defence?

Absolutely ‘yes’—it’s simply a matter of priorities. Many countries spend more than 2% of GDP on defence and Australia did so continuously from 1939 to 1992. What’s more, Australia is now much more prosperous (in terms of real GDP per capita) than back in those days. So, in theory at least, the opportunity cost of higher defence spending would be less acutely felt than in the past.

Of course, that’s not the way people think. In a developed country such as Australia, individuals judge economic utility in terms of more or less rather than in absolutes. We desire shiny new granite kitchen benches just as much as our grandparents desired plumbed toilets; and just like our grandparents, we expect our living standards to rise year on year.

All other things being equal, higher levels of defence spending impose an opportunity cost in terms of some combination of private consumption and government services. Critically, the new government has placed the burden of accommodating increased defence spending on the latter, by promising that each year the government will be a smaller percentage of the economy. To make the task even more difficult, they’ve also promised to have a budget surplus of 1% of GDP.

Thus, under the new government’s plan, the share of expenditure exclusive of defence will fall by more than 1.4% of GDP (0.4% extra for defence and 1% for the surplus) over the next decade. That equates to a roughly 7% decrease in the share of government revenues going to non-defence areas such as health, education and social welfare.

If we’re lucky enough to enjoy consistent and robust economic growth, and tight controls are kept on non-defence spending, this is possible. But it won’t be easy; the cost of delivering current levels of health, education and social programs will increase in real terms over the next decade, and demand for higher levels of service in these areas is unlikely to abate any time soon.

Is it necessary to spend 2% of GDP on defence?

Setting aside my own heretical views on how much Australia should spend on defence, the very notion of setting a target for defence spending in terms of GDP share is hard to fathom. I have three objections.

First, defence spending should be determined by a sober analysis of the costs it imposes relative to the strategic risks it mitigates. A set percentage of GDP is arbitrary, pure and simple. As Andrew Davies put it, the goal is ‘divorced from a coherent strategic framework’.

Second, a set share of GDP places the funding of defence at the mercy of the winds of economic fortune. Irrespective of what’s happening in the strategic environment and the practical demands of executing a coherent defence plan, defence spending will grow during booms and fall during recessions.

Third, it begs the question of what the forthcoming Defence White Paper is meant to do. If the defence spending is already set as an independent variable, the most fundamental question in strategic planning—how much is enough—is off the table from the start. All that remains is for the Services to divide up the ever-expanding bucket of taxpayer’s money according to their parochial wish lists.

And there’ll be plenty of money available to divvy up if the government keeps its promise. The Gillard government’s plans for defence spending would have only taken defence spending to 1.64% of GDP in a decade’s time, and even Kevin Rudd’s 2009 plan would have only achieved 1.85%. To the extent that the folks on Russell Hill believe that the new government will deliver on its promise, they must be pinching themselves.

Is it really going to happen?

There will be at least three elections between now and 2022, and a lot can change over that time. Defence expenditure will undoubtedly be shaped by political, economic and strategic developments between now and then—as it should. But plans for a decade’s time have to be made now, and for the moment those plans include spending 2% of GDP on defence.

As a practical matter, it’s no trivial thing to increase defence spending from 1.6% to 2.0% over a decade. By my estimate, it’ll require around 5.3% real growth each year to get there, assuming steady growth. And there really isn’t a viable alternative to consistent steady increases. As the Howard years showed, even increasing defence spending by 3% each year stressed Defence’s capacity to absorb additional funds—especially in the capital investment program.

If the government is going to make good on its promise of spending 2% of GDP on defence within a decade, they can’t afford to skip a year or two of growth and then try and play catch up. Resisting the urge to do so in a couple of years’ time when a surplus is within reach will be the test of how seriously their promise can be taken.

Mark Thomson is senior analyst for defence economics at ASPI.

All other things being equal, higher levels of defence spending impose an opportunity cost in terms of some combination of private consumption and government services. Critically, the new government has placed the burden of accommodating increased defence spending on the latter, by promising that each year the government will be a smaller percentage of the economy. To make the task even more difficult, they’ve also promised to have a budget surplus of 1% of GDP.

Thus, under the new government’s plan, the share of expenditure exclusive of defence will fall by more than 1.4% of GDP (0.4% extra for defence and 1% for the surplus) over the next decade. That equates to a roughly 7% decrease in the share of government revenues going to non-defence areas such as health, education and social welfare.

If we’re lucky enough to enjoy consistent and robust economic growth, and tight controls are kept on non-defence spending, this is possible. But it won’t be easy; the cost of delivering current levels of health, education and social programs will increase in real terms over the next decade, and demand for higher levels of service in these areas is unlikely to abate any time soon.

Is it necessary to spend 2% of GDP on defence?

Setting aside my own heretical views on how much Australia should spend on defence, the very notion of setting a target for defence spending in terms of GDP share is hard to fathom. I have three objections.

First, defence spending should be determined by a sober analysis of the costs it imposes relative to the strategic risks it mitigates. A set percentage of GDP is arbitrary, pure and simple. As Andrew Davies put it, the goal is ‘divorced from a coherent strategic framework’.

Second, a set share of GDP places the funding of defence at the mercy of the winds of economic fortune. Irrespective of what’s happening in the strategic environment and the practical demands of executing a coherent defence plan, defence spending will grow during booms and fall during recessions.

Third, it begs the question of what the forthcoming Defence White Paper is meant to do. If the defence spending is already set as an independent variable, the most fundamental question in strategic planning—how much is enough—is off the table from the start. All that remains is for the Services to divide up the ever-expanding bucket of taxpayer’s money according to their parochial wish lists.

And there’ll be plenty of money available to divvy up if the government keeps its promise. The Gillard government’s plans for defence spending would have only taken defence spending to 1.64% of GDP in a decade’s time, and even Kevin Rudd’s 2009 plan would have only achieved 1.85%. To the extent that the folks on Russell Hill believe that the new government will deliver on its promise, they must be pinching themselves.

Is it really going to happen?

There will be at least three elections between now and 2022, and a lot can change over that time. Defence expenditure will undoubtedly be shaped by political, economic and strategic developments between now and then—as it should. But plans for a decade’s time have to be made now, and for the moment those plans include spending 2% of GDP on defence.

As a practical matter, it’s no trivial thing to increase defence spending from 1.6% to 2.0% over a decade. By my estimate, it’ll require around 5.3% real growth each year to get there, assuming steady growth. And there really isn’t a viable alternative to consistent steady increases. As the Howard years showed, even increasing defence spending by 3% each year stressed Defence’s capacity to absorb additional funds—especially in the capital investment program.

If the government is going to make good on its promise of spending 2% of GDP on defence within a decade, they can’t afford to skip a year or two of growth and then try and play catch up. Resisting the urge to do so in a couple of years’ time when a surplus is within reach will be the test of how seriously their promise can be taken.

Mark Thomson is senior analyst for defence economics at ASPI.

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