Articles by " Mark Thomson"

First principles review: one more round of external oversight

Aerial photograph of Russell Offices. Mark Thomson writes that while it might be politically expedient to quarantine military personnel from scrutiny, they represent more than three-quarters of the Defence workforce and are the most expensive on a per-capita basis. The multiple military headquarters maintained by the ADF are likely to be every bit as overstaffed as those on Russell Hill.On 5 August, eleven months after coming to office, the government finally announced its long-promised First Principles Review of Defence. Although the review’s terms of reference have not been formally released, the minister effectively outlined them in a recent speech saying that the review would make recommendations to:

  • ensure that the Department of Defence’s business structures support the ADF’s principal tasks, as determined by the 2015 Defence White Paper, and other whole of government responsibilities out to 2030
  • ensure a commercially astute, focused and accountable materiel acquisition and sustainment capability
  • improve the efficiency and effectiveness of Defence
  • guide the implementation of recommendations from the Commission of Audit not otherwise covered above, and
  • ensure the ongoing delivery and reporting of agreed recommendations

It’s probably not wise to read too much into the points above. For example, it’s hardly likely that the Review will uncritically accept the recommendations of the National Commission of Audit (or let’s hope not). Nevertheless, the government’s goals are clear: make Defence efficient and effective, reform the Defence Materiel Organisation, and ensure that any recommendations are carried out. Read more

The review will be headed by David Peever, ex-managing director of mining powerhouse Rio Tinto Australia (and newly appointed Cricket Australia Deputy Chairman). Assisting him will be ex-chief of army Peter Leahy, BAE Systems executive Jim McDowell, ex-defence minister Robert Hill and ex-finance minister Lindsay Tanner.

In the weeks ahead, I will post on many of the issues that fall within the terms of reference (along with a few that don’t). With a major review underway, it would be good to see a public discussion about how best to structure and manage the multi-billion dollar Defence enterprise. In the remainder of this post, however, I want to reflect on the practice of having external reviews of Defence and provide some background.

As the following timeline shows, successive governments have brought in outsiders to assist in the quest to create a more efficient and effective Department of Defence.

In 1989, Kim Beazley tasked ex-ASIO head Alan Wrigley to review civil support to the defence force. The result was the Commercial Support Program (CSP), which saw thousands of uniformed and civilian positions outsourced from Defence through the 1990s.

In 1996, Ian MacLauchlan initiated the Defence Efficiency Review (DER) chaired by CSIRO head Sir Malcolm McIntosh. The result was the Defence Efficiency Program (DRP) which accelerated the outsourcing of jobs, rationalised the defence estate, and established the current ‘shared services’ business model within Defence. The goal was to generate $1 billion dollars a year in savings.

In 2007, Brendan Nelson launched the Defence Management Review in the wake of the failed repatriation of Pte Jacob Kovco from Iraq. Headed by ex-state government bureaucrat and businesswoman Elizabeth Proust, the Review led to some additional deputy-secretary positions but not much more.

In 2008, Joel Fitzgibbon hired management consultant George Pappas to undertake the Defence Budget Audit (DBA). The result was the Strategic Reform Program (SRP), which made widespread but largely incremental reforms to Defence from 2009 to 2012 in an attempt to generate more than $20 billion in savings over a decade.

In 2011, Stephen Smith commissioned a raft of ‘cultural reviews’ following the Skype scandal at the Australian Defence Force Academy, all but one of which was headed by an external party. In the same year, Smith also commissioned a Review of the Defence Accountability Framework headed by ‘ethicist, theologian and strategic advisor’ Rufus Black.

Why has government after government felt it necessary to use external people to recommend changes to Defence? It’s not that the organisation lacks high-paid talent; on the contrary, the past decade has seen strong growth in civilian and military executive positions. More importantly, Defence often impresses; it routinely executes complex military operations at short notice, and is capable of formulating innovative policies such as the recently announced enhanced workforce model. So why doesn’t the government rely upon its principal advisors—the Secretary and Chief of the Defence Force—to sort things out.

To start with, there’s inherent value in seeking outside perspectives. The specialised nature of the work means that many people in Defence—especially in the military—have limited experience of the world beyond. External reviews bring external perspectives unavailable from within the organisation.

But to my mind the real advantage of an outside review is that it brings a degree of objectivity impossible for those engaged in the internecine politics of Defence. Everyone, by position or past, has a vested interest in protecting their part of the organisation. More generally, when it comes time to trim the accumulated fat from the body bureaucratic, there’s no point handing the scalpel to the patient. Let’s hope the newly appointed review team has a steady hand.

Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of Department of Defence.

The British are coming

The British are coming!

Last week, The Australian broke the story of BAE Systems potentially being brought in to fix the troubled Air Warfare Destroyer project. The three-ship build is already well underway in Adelaide, and the project is currently managed through an industrial alliance contract involving government-owned ASC Pty Ltd, Raytheon Australia and Defence.

Approved at a cost of $8.5 billion dollars in 2007, the project has accumulated nearly two years of delays and $300 million in additional costs. A government-initiated review of the project by ex-US Secretary of the Navy Don Winter and former Transfield boss John White recommended a range of measures, including ‘the urgent insertion of an experienced shipbuilding management team into ASC’.

But while the summary of the Winter/White report was announced by government just two months ago, the AWD Alliance had taken steps before that to remedy some of the project’s shortcomings. One of us (Andrew) visited the site at Osborne last week, and it was clear that some good work has been done. Read more

When the Australian National Audit Office reported on the project in March, many of the identified problems related to the transfer of the design from Spain to Australia, and the inexperience of the Australian workforce after more than a decade without a build project. Those factors contributed to a poor start to the project. Low productivity was the inevitable result, due to reworking of both the design and often the hardware. As a result, the first-of-class HMAS Hobart took shape fitfully and inefficiently.

A critical question is whether the existing project management and workforce can retrieve the situation. The answer seems to be a ‘qualified yes’. The Alliance has recruited some experience in production engineering and is seeing positive results. Visits to the yard at about the same stage of progress on ships 1 and 2 revealed a huge difference between the two. The blocks for ship 2 in the yard are more complete (with internal piping, painting, insulation etc) and are constructed to tighter tolerances than the first. For example, when the upper blocks were first lowered into position on ship 1, a substantial gap resulted. On ship 2, the parts fitted neatly together. The already in situ features in the modules mean there’s less need for work in tight and cramped spaces (in particular, the need for difficult overhead work is greatly reduced). The reduction in labour hours required from the first to second of class will be well over 20%, with further improvements expected for ship 3.

The ‘yes’ has to be qualified because there’s still substantial work to be done before a functional warship is delivered. In particular, the capability of the vessels will depend critically on how the Aegis combat system and other sensors and weapons function together. The job of building integrated systems into the hulls is yet to come, although land-based integration is well advanced.

Perhaps because of those improvements, news of BAE’s putative role has taken many by surprise, even though the government showed its cards by appointing a team of corporate lawyers and investment bankers as strategic advisors back in June. By seeking out mergers and acquisition specialists (rather than shipbuilders), the government revealed its inclinations.

So what might we expect if BAE is brought in? At a minimum, BAE could provide individuals with shipbuilding expertise to assist ASC. More likely, BAE would be asked effectively to take charge of the project. It’s even possible that BAE would take an equity stake in ASC’s shipbuilding arm—perhaps contingent on completing the AWD project. (There are good reasons to retain ASC’s submarine maintenance role in government hands, at least for the time being.)

BAE taking charge of the AWD project—if that’s indeed what’s to happen—would bring benefits and risks. On the positive side, BAE could reach back to the UK for help. Of course, BAE’s own problems with module construction for the AWD, and their trials and tribulations with the LHD project, show that they’re capable of overestimating their own abilities. If nothing else, however, BAE would bring the commercial focus that the government-owned ASC lacked. And they’d have every incentive to do so; not only will their reputation be on the line, but success with the AWD would likely secure them the massive eight-vessel Future Frigate Anzac replacement next decade.

On the other hand, the disruption that’s an inevitable result of a change of management would have to be carefully handled. While BAE has experience as a subcontractor, there’d still be a lot for them to learn about the project. The challenge would be to ensure continuity of effort concurrent with the introduction of new blood. As we’ve seen, ASC hasn’t been sitting on its hands. A lot would depend on the attitudes taken by the parties involved and cooperation will be critical. If it happens, let’s hope that the intervention adds more than it subtracts from the project’s likelihood of success.

As ever, the devil’s in the details, and another post will discuss the intricacies of third-party intervention and what the alternatives might look like.

Andrew Davies is senior analyst for defence capability and director of research at ASPI. Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of Flickr user Kayla Casey.

The elephant in the conference room

Is that an elephant in the room?

The worst-kept secret at the DMO Defence and Industry conference this week was the government’s active consideration of buying submarines from Japan. Although it was never mentioned in any presentation, Option J, as it has come to be known, was discussed in every corner and corridor of the Adelaide convention centre.

Good policy rarely results from secret deliberations shielded from public scrutiny, so I think it’s time to discuss Option J directly, at a level beyond passing media speculation.

As recently as a month ago, the Abbott–Abe strategic cozying up seemed likely to deliver little more than access to Japanese submarine technologies—in particular, the propulsion system. But today it appears that the government is actually considering having replacements for the Collins built in Japan. Read more

Before going any further, it’s worth noting that would be a move laden with geopolitical consequences. The export of Japanese submarines to Australia would represent a much more rapid normalisation of Japan’s defence posture than anyone has anticipated so far. It would alarm China and heighten Beijing’s fears of containment by the United States and its US allies. Those are serious first-order strategic considerations not to be dismissed lightly or as somehow secondary to the reasons for acquiring submarines in the first place.

But for the moment, at least, I’ll leave it to others to argue the strategic merits and risks of the proposal and focus instead on the question of whether Option J represents a credible path to the cost-effective delivery of submarines to meet Australia’s needs.

It’s commonly believed that Japan builds and operates capable submarines of a displacement commensurate with Australia’s needs. Moreover, they do so through a mature industrial arrangement that exploits dual sourcing to deliver efficient construction and maintenance. So far, so good. The trouble is that, at least in the public domain, we know little about the range, endurance, sensor effectiveness and acoustic properties of the vessels.

Even on the basis of what we do know, if Japan is willing to sell us submarines, we should be looking closely at what they have to offer to see if it meets our needs, or might meet our needs with some modification. For example, we’d almost certainly want to equip the vessels with US weapons and combat systems.

The option of building submarines offshore will alarm Australia’s domestic shipbuilders who have been waiting patiently to play a role in what was long promised to be a domestic program. I’m largely agnostic about building offshore, provided that appropriate steps are taken to ensure the availability of cost-effective and strategically necessary in-country support the fleet will need.

The fear among many people I’ve spoken to, and which I share, is that Option J is being driven at the political level in the absence of the due diligence needed for a multi-billion dollar critical defence acquisition. Japan isn’t the only country that builds submarines. France, Germany and Sweden all have credible products and a declared interest in helping Australia fulfill its submarine needs.

We need something more than a beauty contest—which appears to be all that’s currently planned—that rushes to a decision. With three or four credible contenders we need to see what’s on offer and use competitive mechanisms to secure the best possible deal for the Australia taxpayers.

The bare bones of what we should do is straightforward:

Step One would be to seek formal expressions of interest from prospective suppliers for both in-country and foreign-build boats, based around a clear statement of what Australia wants in terms of platform performance, US-system compatibility and, critically, efficient through-life support in Australia.

Step Two would be to select the two best contenders, or three if absolutely necessary, and conduct funded preliminary design studies. Preliminary design studies would allow decisions to be made on the basis of reasonable estimates of the cost and capability available from the selected firms.

Of course, the conduct of the second stage would be more complex than the simple picture I’ve painted. For example, for domestic construction, the involvement of local firms complicates matters somewhat. But the principle underlying my proposal is simple: in the absence of competitive pressure to contain costs and negotiate affordable through-life support we’ll find ourselves at the mercy of the supplier for the next thirty years.

Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of Flickr user Justin Elson.

Defence projects, jobs and economic growth

HMAS Anzac under tow as it prepares to re-enter the water from Henderson Naval Base where it spent twelve months undergoing an upgrade.

In a recent post, Andrew Davies explained how the government ignored Defence’s advice and chose the MRH90 over the Black Hawk helicopter—presumably because the former offered more for local industry.

There’s nothing intrinsically wrong with considering industry factors in defence procurement. As John Harvey reminded us, a local preference can legitimately be based on defence self-reliance and/or broader economic benefits. Consistent with this, government announcements routinely tout the economic benefits of defence projects. For example, this year’s F-35 announcement said:

The acquisition of F-35 aircraft will bring significant economic benefits to Australia, including in regional areas and for the local defence industry with more jobs and production for many locally-based skilled and technical manufacturers.

The message is clear; the more work that’s done in Australia the better. In the case of the F-35, it’s likely true. Rather than rely on offsets, Australian firms compete with foreign manufacturers to supply the global F-35 program so that only internationally competitive firms thrive. In other instances, local sourcing occurs absent foreign competition and at a sizable cost premium, such as the troubled Air Warfare Destroyer Project where we are getting three vessels for the price of four. Read more

What’s the lure of having work done locally? Apart from expectations of achieving greater self-reliance and more cost-effective through-life support (each a canard for another post), decision-makers probably believe that there’s a net economic benefit from having work done in Australia even at a premium.

The notion that local production delivers an economic benefit has been cultivated by those eager to avoid foreign competition. DefenceSA, the South Australia Government’s defence lobbying arm, has produced two glossy publications (here and here) that extol the economic and industry benefits of local shipbuilding.

The DefenceSA reports quote an economic analysis of the Anzac Ship project commissioned by the Australian Industry Group in 2000. The scanned copy of report can be found here (PDF) and its companion report on the Huon minehunter project is here (PDF). The reports employ two methodologies to estimate the economic impact of projects: input-output multiplier analysis and general equilibrium modeling.

Multiplier analysis estimates the gross economic impact of spending, and the table below summarises the key results from the Anzac and Huon reports:

Input-Output Multiplier analysis of recent major naval construction projects

Project

Cost

National output

Jobs

Anzac frigates

$5.6 billion

$10.9 billion

57,000

Huon minehunters

$1.0 billion

$1.7 billion

9,250

Impressive numbers indeed! If only the world was so simple; multiplier analysis overestimates economic impacts by ignoring (along with much else) constraints on, and alternative uses of, inputs to production. For example, multiplier analysis assumes that each and every person employed by the project would be unemployed had the project not occurred. The Productivity Commission released a paper on the uses and missuses of multiplier analysis in 2013.

Mindful of the limitations of multiplier analysis, the Anzac and Huon reports also used general equilibrium modeling to estimate the economic impact taking account of input constraints on the Australian economy as a whole.

General equilibrium modeling of recent major naval construction projects

Project

Cost

GDP increase

Jobs increase

Anzac frigates

$5.6 billion

$3 to 7.5 billion

7,850

Huon minehunters

$1.0 billion

$887 million

1,860

Unlike the input-output analysis, the estimated boosts to GDP and employment in the table above are net increases across the entire economy. How much confidence can we have in those estimates? Comparison with analogous estimates in a 1994 Industry Commission report are informative. Depending on the assumptions made—none of which were unreasonable—an increase in local defence sourcing could result in either an increase or decrease in GDP and employment. Confused yet?

As best I can tell (not being an economist) two assumptions drive the results. First, the extent to which employment is held as a fixed constraint in the model. Second, the assumed productivity enhancement arising in firms engaged in the project. Weak employment constraints and higher productivity yield greater benefits, and vice-versa.

Given ongoing strong competition for skilled labour and the low productivity of (at least) the naval shipbuilding sector, recent local purchases such as the AWD have probably not had anything like the bountiful impact claimed by the Anzac and Huon analyses—certainly nothing like what would be needed to cover the substantial premium being paid.

Nonetheless, we should be wary of definitive claims either way about the economic impact of buying defence equipment locally. But with $78 million already committed to progress a local build of frigates to replace the Anzacs (wastefully early), the government needs to get some evidence-based advice on the economic costs and benefits of local construction sooner rather than later. As I’ve suggested in the past, the Productivity Commission would be a good place to start.

Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of Department of Defence.

How to buy a submarine – part 2

The building of a replacement for Australia’s Collins class submarines will be the country’s most expensive and complex defence project to date. There are a myriad of capability, commercial and industrial issues to be managed: the expertise for the design and construction of conventional submarines resides in Europe and Asia while Navy’s preference is for American combat and weapon systems. Pulling those elements together while managing the technical risks is no easy task.

Local construction of the future submarine has been a bipartisan position for several years, and it has the support of industry and the bureaucracy. But there’s no simple or fast way to produce a unique Australian submarine. If the government decides to go down that path, it will have to do so in the knowledge that it’s a high-stakes venture.

In April 2014, ASPI held a two-day conference called ‘The Submarine Choice’. At the conclusion, we were left with three disquieting impressions. Read more

First, pursuing an entirely new design will be risky. Conference presenters drove home the message that Australia currently lacks two key prerequisites for success: ongoing collective experience and a highly-trained design, engineering and submarine-specific building workforce.

Second, there’s a worrying disconnect between Defence’s plans and the government’s thinking (to the extent that either are public knowledge).

Third, it was clear that Defence’s thinking on the submarine acquisition strategy was simultaneously prescriptive and vague— prescriptive about the sort of commercial entity it wanted to undertake the submarine project but vague about how to create it.

With those impressions in mind, we decided that it was time to revisit ASPI’s 2009 paper ‘How to buy a submarine’, written when the enterprise was formally instigated. Our paper released today is our attempt to do so.

Sorting out fact from folklore wasn’t easy. Once we thought we had a consistent picture we sent a draft out to most of the stakeholders and interested commercial entities. We received a wealth of feedback and were struck (though not entirely surprised) by the diverse views expressed. It proved impossible to include, let alone reconcile, all of the disparate and sometimes diametrically-opposed opinions.

For example, several respondents told us that a European firm wouldn’t get the permissions required to integrate sensitive US subsystems and submarine technologies onto vessels they designed, while others told us that the issue was entirely manageable. One possible explanation for the apparent disconnect is commercial interest—for a number of players circling the submarine program, it’s a convenient story. We’re not sure which version is true, but there’s little doubt that the merger of a European design and American combat system is possible under some circumstances—after all, that’s what the Collins is. Our recommendation as a sensible early step in the process would be for Australia to have government-to-government discussions with the potential players—especially in Washington—to determine what the actual constraints are, and what’s merely unsubstantiated folklore.

Conventional submarine design capability with the experience required is found in France, Germany, Japan and Sweden. The UK hasn’t designed or built a conventional submarine for decades, but the trusted nature of the ‘five eyes’ intelligence relationship and its ongoing nuclear submarine programs means that it’s also a potential partner if access to American technology is the issue some claim it to be.

Of the Europeans, France and Germany have established export markets, and have exported designs for construction elsewhere. The Swedish submarine industrial base is currently undergoing significant changes, but the close relationship between the Swedish and US Navy submarine arms makes them a credible contender. Japan’s an established builder of large conventional submarines and there’s high-level political support on both sides for a collaborative effort—and this is rapidly developing into one of the more likely options.

Then there’s the Australian end of the arrangement. The most recent public statements from officials suggest that their preferred approach is similar to the Collins project: the creation of a commercial entity specifically to execute the design and build. The advantage would be that a purposely-created Australian-based entity could manage the interplay of participating European and American firms and their intellectual property. However, having gone in this direction, the government would carry the majority of risk associated with the project from the start.

Other approaches are possible. Most simply, the government could test the market and contract an existing international submarine designer/builder to undertake the project. Not only would this result in a cleaner commercial relationship, it would also give the Commonwealth a commercial counterpart with sufficient financial depth to shoulder a share of the risk in the project.

Finally, there’s always the possibility that the government will weigh up the issues we describe in this paper and decide that it’s all too difficult. In that case it’d need to decide whether offshore procurement options are able to deliver the required capability—or find an acceptable compromise between capability and risk.

Andrew Davies is senior analyst for defence capability and director of research at ASPI. Mark Thomson is senior analyst for defence economics at ASPI. Strategic Insight ‘How to buy a submarine: part 2′ is available free to download hereImage courtesy of Flickr user n1ct4yl0r

Shipbuilding—Australian style

Anzac class frigate HMAS Perth at the International Fleet Review,  October 2013. Minister for Defence, Senator David Johnston, has announced the government would 'bring forward preliminary engineering and design work necessary to keep open the option of building the future frigate in Australia'.Last Friday, the defence minister announced no fewer than three shipbuilding initiatives.

First, to the dismay of the Australian Manufacturing Workers Union (PDF) and the indignation of the opposition, the government announced that it would seek bids from Spain and Korea to build two new replenishment vessels for the RAN. The new vessels will replace the ageing replenishment vessel HMAS Success (18,000 tonnes) and the modified commercial tanker HMAS Sirius (47,000 tonnes).

Although the vessels could’ve been built in Australia, it makes sense to go offshore. Not only would a local build require new infrastructure, but the low productivity of local yards would further drive up the cost. Given the benchmark of the AWD, where we’re getting three vessels for the price of four (and counting), the local premium would be upwards of 33%.

Nonetheless, the vessels won’t come cheap. The Spanish spent around A$350 million dollars to build SPS Cantlarbia (19,000 tonnes), while the British have ordered four Tide Class vessels (37,000 tonnes) from Korea for around A$240 million each. Defence’s 2012 estimate for the two vessels (PDF) was above $1 billion, so the taxpayer is at least a couple of hundred million dollars ahead. Read more

The government also announced plans to build more than 20 steel-hulled patrol boats in Australia. These vessels will replace the 22 boats currently operated with Australia’s assistance by 12 Pacific island states under the Pacific Patrol Boat Program. The specification of steel hulls will disappoint Australia’s highly-capable aluminum shipbuilders, but it has probably been justified by the need for robust, easily-maintained vessels.

The local sourcing of the patrol boats looks to be a sop to Australian industry; Asian shipyards could undoubtedly build the vessels much more cheaply. What’s more, the small size and simple design of the vessels will do nothing to nurture the high-end skills needed for future local projects such as the new submarines.

To make matters worse, the Minister has said the project will ‘generate additional work for yards around Australia’. Thus, rather than capturing economies of scale at a single site, work will be shared around the country, resulting in duplicated fixed costs and multiple company overheads. The only consolation is that the slug to the taxpayer from the patrol boats will likely be less than the saving on the replenishment vessels. Viewing the former as the political quid pro quo for the latter, there’s still a net gain.

Without doubt, the most interesting announcement was that the government would ‘bring forward preliminary engineering and design work necessary to keep open the option of building the future frigate in Australia’. Taken at face value, that announcement is difficult to fathom. A replacement for the Anzac frigates has long been planned for the end of the 2020s, and the prevailing assumption has always been that the vessels would be built locally. To achieve that, the 2012 Defence Capability Guide (PDF) planned on first-pass approval around 2019-20 and second-pass around 2022-23. So there’s plenty of time for a local build.

Rather, the option that’s being kept open now is a specific proposal that industry has been pushing quietly behind the scenes. The suggestion is to take the combat system and radar developed for the Anzac frigates by the Australian companies CEA Technologies Australia and SAAB Combat Systems, and to incorporate them into hulls like those currently being built by ASC for the new destroyers.

As well as leveraging the highly successful work done on the Anzac frigate upgrade, the proposal has the potential to provide continuity of work for ASC and its subcontractors. By doing so, it’s argued, hard-won productivity gains on the AWD project (assuming they eventually materialise) can be used to reduce the cost of the future frigates. What could be better—the incumbent firms each get a piece of the pie and the taxpayer saves some money?

But wait a second. On known plans, substantive work on AWD fabrication will end long before it’s necessary to start work on building the Anzac replacements. Even after the two-year delay to the AWD, fabrication will have ended by 2018 and work on the new frigates isn’t due to start until post 2022. So what’s going on?

A hint can be found in Defence’s 2013 Future Submarine Industry Skilling Plan (PDF) (subtitled A Plan for Australia’s Naval Ship Building Industry). Turn to page 170 and look at Scenario 7. There’s the solution: we can achieve continuity by retiring the Anzacs early. The previous government confirmed this when it talked about ‘bringing forward the replacement of the current Anzac Class frigates’.

There’s no way that marginal productivity gains from continuity will offset the cost of recapitalising the frigate fleet four or five years early. While other nations are looking at how to keep their vessels in service for longer, we’re doing the opposite just to keep our shipbuilders in profit for longer. I despair.

Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of Wikimedia Commons.

The cost of Defence: eighty million, two hundred & eighty-one thousand, three hundred & ninety-one dollars & seventy-eight cents per day

MarkThomson_CoDJust as humour is good provided it’s funny, promises are good provided they’re kept. This year’s defence budget was about a promise; the Prime Minister’s election promise to boost defence spending to 2% of GDP within a decade.

I reported the headline figures for Defence the morning after the budget. Briefly, defence spending will increase by $2.3 billion next financial year to an all-time high of $29.3 billion amounting to 1.8% of GDP. On current plans, spending will remain more or less at that level in real terms for the next three years before increasing in the fourth. In a federal budget dominated by fiscal consolidation, it was as good an outcome for defence as could have been expected. Read more

There’s no doubt the government demonstrated a strong commitment to defence in this budget. Although much of the year-on-year increase reflects a combination of pre-existing funding programmed by the previous government and foreign exchange supplementation, it was always open to the government to add Defence to the list of portfolios reeling under cuts. But aside from a $75 million efficiency dividend spread over four years, the promise of no further cuts to the defence budget was kept.

Apart from helping to alleviate near-term budget pressures, the funding granted to Defence provides a credible path to achieving 2% of GDP in 2023-24 as promised. The path isn’t an easy one; to meet the target on the basis of the funding disclosed for the next four years, expenditure will have to increase at a rate of 5.3% above inflation for the six years after that. But with three to four years to plan and prepare, it would be learned helplessness to suggest that it can’t be done.

In the meantime, there are some serious challenges for Defence to surmount. To start with, the recovery in defence spending next year will deliver a surge in major equipment investment (because that’s the part of the budget that accommodated most of the cuts of the past few years). Equipment investment will grow from around $3.5 billion this year to $6.1 billion next year.

Normally, such a massive year-on-year increase would be unachievable but the high number of off-the-shelf purchases will help make it manageable. And even if money ends up being handed back, it will have been worth the risk to regain momentum in the investment program.

At the same time, Defence needs to get its workforce numbers into better health. There’s no point buying equipment if there are insufficient people to crew the assets. For three years in a row, permanent numbers in the ADF have fallen despite plans to the contrary. Numbers for this year stand at around 56,400, with a target of 59,600 four years hence.

Assuming that those near-term hurdles can be surmounted, the path to spending 2% of GDP is clear—provided the government makes good on its promise. Sometime in the next several years the imperative to return the federal budget to surplus has the potential to perturb but not necessary derail progress. If the government wants to spend 2% of GDP on defence, there’s no fundamental economic reason it can’t. From a fiscal perspective, however, it’ll have to find a way to convince taxpayers to accept the higher taxes and/or reduced services necessary to fund the venture.

If it can, the question is where the path leads in terms of the future development of the ADF. 2% of projected GDP in 2023-24 is a lot of money; around $42 billion in today’s terms. Extrapolating current trends in personnel and operating costs, there’ll be around $112 billion available for capital investment in the forthcoming decade as a consequence, compared with only $66 billion for the decade just past (both measured in today’s dollars). It appears, therefore, that the ADF will need to grow to accommodate the additional money that’s been promised.

If capital investment is capped at 30% of the budget (compared with a historical average of 27%) there’ll be enough money in 2023-24 to increase the size of the ADF by around 10,000 people.

The risk in providing such generous funding to Defence is that proposals of progressively diminishing merit will be brought forward in coming years—for both new equipment and personnel. The challenge for the government will be to ensure that generous funding doesn’t translate into wasteful spending.

Our first insight into what the government has in mind is likely to be the 2015 Defence White Paper, which hopefully will tell us why it’s necessary to spend so much money, and explain what sort of defence force it will buy.

You can read the Cost of Defence here.

Mark Thomson is senior analyst for defence economics at ASPI. Image (c) ASPI 2014.

The 2014 Defence budget—as good as it gets!

Defence Budget 2014In two weeks’ time, ASPI’s annual Cost of Defence will hit the streets, detailing the ins and outs of the 2014 Defence budget. For those who can’t wait, here’s a preliminary analysis of the key points.

In the current fiscal environment, it was a surprisingly good budget for Defence. Spending will rise to $29.3 billion next financial year, a nominal increase of $2.3 billion on what was spent this year and a real (corrected for inflation) increase of 6.1%. As a share of GDP, defence spending will rise from 1.7% this financial year to 1.8% next year.

The key initiatives in this year’s defence budget was the reprogramming of $2 billion from 2017–18 which resulted in an additional $500 million this year (2013–14) and an additional $300 million, $550 million and $150 million respectively across the next three years. Yes, that’s right; despite the government’s fiscal consolidation, Defence will get extra money four years in a row. Read more

On the savings front, there’s $1.2 billion to be saved over the next four years from ‘back office’ reforms, all of which will be available for reinvestment in capability—ie Defence will retain the money generated. Consistent with this, the number of civilians employed will fall from 20,900 today to 18,600 in four years’ time.

Over the next three years, defence spending is slated to remain largely static in real terms before rising to $30.6 billion in 2017–18. Beyond that, we don’t have visibility of what’s planned. But for the government to make good on its promise to boost defence spending to 2% of GDP by 2023–24, they would need to increase defence spending by around 5.3% every year for the six years following the forward estimates period.

On past experience, a sustained 5.3% rate of growth will be challenging to achieve. During the 2000s, when defence spending was growing at around 3% a year, Defence and defence industry had trouble absorbing the increase—to the extent that substantial sums of money were handed back. However, this time, there are 3–4 years available to prepare for the ramp-up so we can perhaps be more optimistic. Moreover, there’s nothing to stop the government from using future budgets to ease the task by commencing growth towards 2% of GDP prior to 2017–18. Indeed, one of the critical decisions for the forthcoming white paper will be the funding envelope from 2015 onwards.

A potential complication is that the government plans to return the Commonwealth to surplus around 2018–19, just after it looks as though defence spending will take off. If the government’s fiscal projections turn out to be overly optimistic, there’ll be pressure for further savings in order to preserve the surplus. If this happens, defence spending can’t expect to be immune.

Notwithstanding that risk, this year’s defence budget is about as good as it gets in an environment dominated by fiscal concerns. Not only has Defence received more money in the near term, but a credible path to 2% of GDP has been established.

Mark Thomson is senior analyst for defence economics at ASPI. Graph (c) ASPI 2014.

Defence reform after the National Commission of Audit

Aerial photograph of Russell Offices. Mark Thomson writes that while it might be politically expedient to quarantine military personnel from scrutiny, they represent more than three-quarters of the Defence workforce and are the most expensive on a per-capita basis. The multiple military headquarters maintained by the ADF are likely to be every bit as overstaffed as those on Russell Hill.

The National Commission of Audit’s report created quite a stir last week; pension ages to rise, family payment to fall, and a new model for federation. For those who lack the time to study the Commission’s five volumes, a summary of recommendations for Defence is here. The recommendations fall into three categories:

First, in the politest way possible, the Commission recommends that the government base defence spending on an analysis of capability options and strategic risks rather than adhere to its commitment to spend 2% of GDP. This is a sound recommendation, but it’s not one that the government is likely to embrace publicly given the politics of promises.

Second, there’s a series of discrete recommendations about a grab-bag of issues, including budget processes, ministerial directives, reintegrating DMO into Defence, professionalisation of Capability Development Group, new performance indicators, sale of ASC Pty Ltd, privatisation of Defence Housing Australia, closing the Military Superannuation and Benefits Scheme, ceasing the Skilling Australia Defence Industry Program, and assessing the potential of the Defence Science and Technology Organisation for outsourcing. Read more

The pros and cons of the various recommendations will be explored in the forthcoming ASPI Defence Budget Brief. For the moment, it’s sufficient to observe that they are mostly secondary matters in the broader landscape of defence reform—despite being of vital interest to those affected.

Third, and most importantly, the Commission recommends two further reviews of Defence in addition to the government’s already planned ‘first principles’ review of structures and processes. The first is a Portfolio Agency Audit designed ‘to comprehensively assess efficiency and effectiveness across all aspects of an agency’s operations, programmes and administration’. The second is a report from the Secretary ‘on current management structures and spans of control, and opportunities for improvement’. Defence has been selected to go first, but other agencies will eventually come under similar scrutiny.

The two proposed reviews supersede several specific recommendations from the Commission about Defence’s staffing and structure. It would make no sense, for example, to ‘reduce the staffing size of Defence headquarters in Canberra, including senior staff, to 1998 levels’ while reviews of Defence’s structure and staffing are underway. For the moment, Defence has been given a reprieve.

So what comes next? Surely it’s time to start the ball rolling on the next round of defence reform.

The first step should be to combine the three proposed reviews of Defence into one. It would be ludicrous to have clipboard-wielding consultants bumping into each other in the hallways of Russell Offices on overlapping missions. With the Audit Commission report done and dusted, there’s no excuse for further delay; set the terms of reference, appoint a team, set a deadline, and get on with it.

Key issues for that combined Review to cover would include:

  • Defence’s structure, processes and staffing, including all aspects of the civilian and military workforce. While it might be politically expedient to quarantine military positions from scrutiny, they represent more than three-quarters of the Defence workforce and are the most expensive on a per-capita basis. The multiple military headquarters maintained by the ADF are likely to be every bit as overstaffed as those on Russell Hill.
  • The future of Defence’s shared services business model and the role of the Service Chiefs. There’s an inherent tension between the efficiencies delivered by organisation-wide shared services (such as information technology, communications, and facilities maintenance) and the clearer accountability of having the three Services manage their own support in-house. Given the progress made in recent years, I think the best option is to further exploit the existing model. Others believe that returning control to the Services is imperative—particularly in the case of materiel sustainment. This issue must be resolved.
  • The future of the Defence Materiel Organisation (DMO). Increasingly more radical schemes for revamping DMO have been doing the rounds in the media. The government needs to develop a plan for DMO, either within the forthcoming broader review of Defence or as an ancillary exercise. In doing so, it’ll be important to consult closely with industry (while remembering that they have a vested interest in creating a pliant and weak commercial counter-party).

Once the Review is underway, the government can have a look at some of the Commission’s discrete recommendations—there’s plenty that’s not contingent on matters to be covered by the Review—and try to get some early runs on the board. The Abbott government came to power with a strong defence reform agenda; it’s time to get on with the task. The sooner they make a start, the better the prospects for meaningful reform in this term of government.

Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of Department of Defence.

The JSF and the issue of ‘new money’

The Chief of Air Force, Air Marshal Geoff Brown, AO gives the Prime Minister, The Hon. Tony Abbott MP, a tour of the cockpit of the 'mock-up' of an  F-35A Lightning II aircraft at Defence Establishment Fairbairn.

Last Wednesday, the Prime Minister and Defence Minister travelled to Fairbairn airbase to announce Cabinet had approved the purchase of a further 58 F-35 Joint Strike Fighters at a cost of $12.4 billion. It should have been a red-letter day for the Abbott government; an election promise fulfilled, Australia’s defences strengthened, and work aplenty for local industry. But it didn’t quite work out that way.

To start with, confusion abounded at the press conference about where the money was going to come from. An increasingly perplexed media tried to make sense of statements like

…this is not new money, it’s money which successive governments have carefully put aside to ensure that our nation’s defences are strong.

 We have been putting the money away, a line item called ‘air combat capability’ and it’s been there, it’s been building up and it’s in the Budget.

 So, this is not new spending today, in the context of a tough Budget, this is spending money that we need to spend that has been sensibly put aside in the past to ensure that our nation’s defences remain strong.

The successive quotes (there are more I could’ve used) reflect persistent questioning by incredulous journalists. You can read the transcript for yourself here.

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As best I can tell, the Prime Minister and Defence Minister were forthright and honest in their answers. For anyone versed in the arcane world of government finance and its curious terms-of-art, the responses make perfect sense. Trouble is, few people are initiated into that club—hence the confusion. More importantly, the media were actually onto something. Let me explain.

There’s no escrow account or trust fund designated ‘air combat capability’. Rather, the notion of money ‘put aside in the past’ refers to a planning provision made in prior years. That is, Defence’s forward financial plan has for many years included a provision to acquire the F-35 around the latter half of this decade. No actual funds have been deposited anywhere, but within the overall funding promised to Defence an allowance has been made for the purchase of the F-35.

Moreover, there’s nothing special about planning provision for the F-35 acquisition. There are similar provisions made in Defence’s financial plan for personnel expenses, fuel, ammunition, gold braid etc., just as there are provisions in the government’s broader financial plan for pensions, hospitals and schools in the years ahead.

By saying ‘this is not new money’, all that’s meant is that the aircraft will be purchased from within the existing funding planned for Defence.

So far so good. But the iron rule of government spending is that each dollar can be spent only once. Every dollar spent on defence is unavailable for spending on health or education or pensions. And on this count, the journalists’ instincts were on target. The money to pay for the F-35 aircraft is yet to be raised by taxes—in fact it’s yet to be earned by taxpayers. Just because someone entered some numbers into a spreadsheet a couple of years ago doesn’t erase the hard fact that the F-35 purchase will impose an opportunity cost in terms of either higher taxes/debt or reduced government spending elsewhere.

Which brings me to the second complication surrounding last Wednesday’s announcement; everybody knew the Treasurer was scheduled to give a speech that evening to make the case for a hard budget—and he delivered in trumps. The result was a bonanza for cartoonists , with Alan Moir, Andrew Dyson, and Ron Tandberg all having a go, and with David Pope weighing in twice (here and here). (My favorite was John ‘Polly’ Farmer’s effort for the Hobart Mercury, but it’s not available online.)

I expect that the government will think twice in future before it announces a multi-billion defence acquisition immediately prior to the Treasurer giving a speech with such choice quotes as ‘we are spending money we don’t have’ and ‘we must learn to live within our means’. But from my viewpoint it was the right thing to do—defence spending and the opportunity cost it imposes on society shouldn’t be sheltered from scrutiny.

On the contrary, just as the Treasurer presented a reasoned and evidence-based case for a hard budget, the government needs to take the same approach to explaining why Australia needs a strong defence. Unless they do, the promise of spending 2% of GDP on defence will prove to be as unsustainable as the budget position the Treasurer described last week.

Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of the Department of Defence.

Submarines by the dozen?

Dozen?

The press has made much of a perceived backing down from a plan to build 12 submarines. We say ‘perceived’ because no-one has actually said that. But it’s true there’s been some very careful language choices around submarine numbers, including by the Defence Minister, here in his speech:

… my primary focus is not on numbers but on the capability and availability of boats required to meet the tasks set by government.

And here in a doorstop:

To [put] a number on submarines is a distraction. What we want is a long term capability that can be sustained as an enterprise, as an asset that can go long into the future building submarines.

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It’s true that the focus ought to be on the delivery of defence capability that’s well-matched to strategy and to the budget. But talk at the conference, both from government and from the bureaucracy, has been about the need for an enduring industrial capability for submarines. While no-one has said so in as many words, an enduring submarine design and build capability all but mandates moving to a continuous build program—the case for which was laid out in detail in DMO’s Future Submarine Industry Skills Plan last year. Another criterion is avoiding any capability gap that might otherwise occur at the end of the Collins-class lifetime.

We think meeting both of those criteria is only really feasible if the fleet constitutes around 12 boats. We’ll explain why below, but first observe that France has 10 boats (and exports others), and still has management challenges in keeping its industrial capability intact. The UK’s fleet of 11 submarines (and no exports) has barely provided enough continuous work. By general consensus, Japan sustains its industrial submarine capacity pretty well through a rolling production model, but it has 16 in service and is expanding to over 20. Maybe we could come up with a model that works with fewer than 12 boats, but clearly we’d have our work cut out.

Other numbers here aren’t especially promising either. As we pointed out in our 2012 Mind the gap paper (PDF), a Collins life extension will take them out to 2030 (and beyond that for a few boats). By then they’ll be around 30 years old—not unusual for naval platforms.

The recent success in improving Collins sustainability has seen a move to a ’10 years on, 2 years in maintenance’ operating cycle (it was previously 8 + 2), allowing more efficient use of those expensive assets. Future boats could thus serve for 22 years as a minimum, and 34 if they do three cycles as the Collins class will come close to.

So if we had 12 submarines and kept them for the minimum 22 years, we’d need a new one every couple of years. If the number fell below 12, we’d have to slow down further, raising the question of what constitutes an efficient use of the investment required to sustain shipyard and design capacity. Such a slow production rate wouldn’t replace the six Collins boats in the right timeframe; we’d have to produce a batch of four to six fairly quickly and then slow down—but then it’d be hard to avoid having 10–12 boats at some stage.

Of course, 22 years is a remarkably short life-of-type for a submarine. So the question is whether the benefits of an ‘enduring capability’ justify the additional cost of replacing vessels more frequently?

A quick estimate isn’t encouraging; moving from a 34 to 22-year lifespan increases the capital cost of maintaining the fleet by more than 50%. Even with potentially higher productivity and potential savings from avoiding mid-life upgrades, it’s likely there’d be a substantial cost premium. Then there’d be the added costs of maintaining administrative and managerial overheads continuously, within both industry and Defence.

A continuous build program of ships and submarines would also lock the government into maintaining the size of the submarine and maybe surface fleets. Navy might see that as an added benefit; no need to make the case for the next generation at replacement time. But from a broader defence perspective it would fix the minimum size of a large and expensive part of the force structure. And from a public policy perspective it would lock in a substantial chunk of what was previously discretionary spending.

Call it what you want—an enduring capability or a continuous build program—it means that we’d be creating either a private or publicly-owned monopoly submarine production entity. As the bad old days of government-owned shipyards demonstrated, ensuring productivity from a monopoly supplier is a far from easy task.

Finally, it’s worth noting that the main rationale for an enduring capability is a desire to meet some ambitious and uniquely Australian requirements—the prime source of cost and schedule overruns in other defence equipment over the years.

Andrew Davies is senior analyst for defence capability and director of research at ASPI and Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of Flickr user sir chalky.

Thinking about submarines

Royal Australian Navy Collins Class submarines exercising off the West Australian coast.

Three presumptions underlie current planning for Australia’s future submarine capability—three ‘musts’. First, the Collins class must be replaced when it reaches its life-of-type. Second, the replacement boats must be built in South Australia. Third, the new boats must have conventional (ie non-nuclear) propulsion.

On Wednesday and Thursday, ASPI’s ‘Submarine Choice’ conference will explore Australia’s future submarine in line with these stipulations. To do otherwise would cause confusion and dismay among the assembled insiders, such is the abiding belief in the need for a conventionally-powered, locally-built replacement for the Collins.

Elsewhere, true believers are harder to find. Among many people I talk to, there’s cynicism about the future submarine—hardly surprising given the twin debacles of the Collins and Air Warfare Destroyer programs. We may be approaching the point where taxpayers think they’re being asked to throw good money after bad. Read more

Yet future policies should be informed by more than past failures. A domestic diesel-electric submarine program should be judged on its merits, taking into account the costs, risks, benefits and alternatives. And while there has been a lot of discussion of large boats in comparison to small boats, and new designs as opposed to existing designs, somewhat less time has been spent examining—or at least explaining—the underlying ‘musts’ that have so far fixed the broad parameters of the program.

When I began preparing for the submarine conference more than a month ago, I found myself drawn to re-examine the underlying presumptions upon which the submarine program rests. My original plan was to produce three short blog posts for The Strategist on the three ‘musts’. I rapidly found myself working through difficult, and often subtle, questions raised by them. Paragraphs morphed into pages, days into weeks. The result is this extended essay (PDF).

Taking the time to re-examine issues already decided might be viewed as an unwelcome diversion from the real job of getting on with replacing the Collins. It isn’t. With so much at stake, each and every aspect of this multi-billion dollar program needs to be continuously examined to ensure that we get it right.

By necessity, the essay is more an exploration of issues than an argument for one course of action over another—I honestly don’t have a firm prescription for how to proceed. All I have to offer is the series of observations summarised below.

  1. No weapons system is worth having at any price. As the cost of weapons systems change, and as the amount of money available for our defence changes, so too does the optimal force structure. Submarines aren’t worth having if they impose too high an opportunity cost on the remainder of the ADF. Depending on the cost of replacing the Collins and the size of the defence budget looking forward, the submarine might need to join the aircraft carrier and long-range bomber as an extinct species in the evolutionary tree of the ADF.
  2. On the basis of existing strategic policy, the strongest argument for retaining conventional submarines rests on the unilateral ability to deter or defeat a South East Asian adversary in a situation where the United States is unable or unwilling to support us. If this conclusion is accepted, two corollaries follow. First, a submarine of more modest ambitions than that outlined in the 2009 White Paper will be adequate for our purposes. Second, the less than existential consequence of such a scenario erodes the imperative of retaining submarines.
  3. The practical, economic and strategic augments for mandating that the next generation of submarines must be built in Australia are unpersuasive. However, the potential benefits to extant players are so concentrated, and the prospective costs imposed on taxpayers are so dispersed, that the political momentum for a domestic build is likely to be unstoppable.
  4. In theory at least, many of the technical and logistical challenges of moving to nuclear propulsion in the next generation of Australian submarines could be surmounted by leasing or buying boats from the US. And while there would remain serious questions about independence of action in some situations, it appears feasible for Australia to operate US boats provided they’re willing to support us in the venture. There’s no reason to think that this would be cheap.
  5. A move to operate US-built nuclear submarines would entail a fundamental shift in Australian strategic policy—from a policy focused on continental defence, to one directly supporting and encouraging a strong US role in the region. The result would be a qualitatively different sort of alliance between Australia and the US with significant repercussions across the region. Ultimately, it’s upon those strategic consequences that the option should be judged, rather than upon the technicalities of nuclear propulsion.

An expanded discussion of each of these points can be found in the essay (PDF) along with much more. I hope readers will have the time to at least take a look.

Mark Thomson is senior analyst for defence economics at ASPI. Image courtesy of Department of Defence.