Budget 2015: a good one for Defence
13 May 2015|
Preliminary analysis as at 12 May 2015

At first glance, the 2015 Budget was a very good one for Defence. Funding will grow to $32.1 billion next financial year, representing a 4.2% real year-on-year increase. And the much-heralded 2% of GDP target finally looks to be within reach, with defence spending set to hit 1.93% next year. But don’t pop the champagne corks yet; all is not as it might appear.

No new funding was actually provided for additional equipment or capability in 2015–16. Instead, the defence budget received $750 million to cover the net additional cost of operations in Iraq and elsewhere, and another $730 million to compensate for the depreciation of the Australian dollar. These no-win no-loss adjustments do not alter the underlying buying power of pre-existing baseline defence funding. At the same time, the GDP percentage was boosted by slower than expected economic growth. On current projections, the GDP share will fall to around 1.8% in 2016–17 as funding stays relatively static and the economy grows.

As for the promise to spend 2% of GDP on defence by 2023–24, that will require seven straight years of 4.6% compounding real annual growth—assuming a steady trajectory (click to enlarge the graph). While shorter, steeper funding paths are theoretically possible, the practical reality is that defence spending can’t be turned on and off like a tap.

Last year, the task looked harder (5.3% per year growth was required) but slower economic growth and a depreciating dollar have eased the challenge. Thus, the good news is that a plausible path to 2% of GDP remains open; the bad news is that 2% of GDP in 2023–24 isn’t worth as much as it used to be. Such is the frailty of basing defence funding on GDP share.

On past experience, Defence and defence industry will find the expansion required to absorb sustained growth of 4.6% difficult to manage. A less risky approach would have been to increase defence spending towards the 2% of GDP target steadily over nine rather than seven years. There’s no reason why this couldn’t have started in this year’s Budget.

The reality is that this year’s budget was a placeholder. We’ll have to await the new White Paper, expected sometime later this year, to see how the government actually plans to reach its target. The White Paper had been promised for March (eighteen months following the election), but things have been progressing more slowly than planned.

Nevertheless, investment in military equipment continues to grow in the meantime. As a result of budget cuts made in an attempt to achieve a surplus in 2012–13, spending by DMO on equipment fell to $3.9 billion that year. In 2013–14 it recovered to $4.4 billion, and then to $6.3 billion in 2014–15. Next year, investment will be $7.2 billion, rising to $10.2 billion at the end of the forward estimates period in 2018–19.

While a plausible path to 2% of GDP remains open, the prospects of it being delivered are unclear. Not only are there three federal elections between now and 2022–23, but there’s also the matter of the surplus (or lack thereof) to grapple with. At the moment, things aren’t looking good.

Back in the 2014 Budget, a surplus was projected in 2018–19, contingent upon the Senate passing the government’s budget measures. This year’s budget delays the happy day until 2019–20, again contingent on the Senate giving the green light to the budget. The risk to defence funding is that a future government will put the brakes on defence spending (and likely much else) in order to break through into surplus. Although this year’s budget appears to have put ‘budget repair’ on the back-burner, the political value of delivering a surplus is traditionally high in Australia. On current projections, a budget surplus will become feasible around the same time as a sustained ramp-up in defence spending is needed to reach the 2% target.

Setting aside the politics of surpluses, the government’s revenue woes have worsened the debt situation. At Budget time last year, net debt was projected to peak at about 14% of GDP in 2016–17. Now, net debt is projected to peak at 17.5% in that same year. Although these aren’t high levels by international standards, they’re uncomfortable for a country such as Australia with a narrow dependence on resource exports.

Looking back to my comments yesterday, it appears as if the government isn’t too worried about the economic risks Australia faces. Rather than focusing on fiscal repair, this looks like a budget crafted to pacify a restless electorate. A more sympathetic perspective might be that the budget is designed to boost productivity and participation. I’ll leave that to this morning’s papers to debate.

In any case, so long as the budget remains in disrepair, the prospects for attaining 2% will remain uncertain. In a perverse way, the binary political calculus of surpluses and deficits means that the government is currently free to spend more on defence at no political cost while still well in deficit. But perhaps that’s as good as it gets. It could be a cold day on Russell Hill when the government eventually gets serious about fiscal consolidation.