Defence projects and the economy
21 Aug 2019|

In response to Australia’s increasingly uncertain strategic outlook, there are now calls to boost defence spending well beyond the current target of 2% of GDP in what’s assumed to be a steadily growing economy. Taxpayer support for bigger spending on defence could depend, in part, on whether it would help or hinder the economy.

My ASPI special report, released today, explores the generic issues involved in increasing the defence budget from a capital equipment perspective, using current major acquisitions of naval vessels and military vehicles as a guide. The economic characteristics of those projects could provide important public policy lessons for future acquisitions. And the projects’ size and longevity could influence what any expanded defence budget can accommodate.

The report highlights the extraordinary difficulty in determining the economic effects of warship and vehicle acquisitions from publicly available data. Despite those projects having a combined value approaching $100 billion in today’s prices, the only project-specific economic impact study released publicly relates to the future frigates.

Similar studies for the future submarines, offshore patrol vessels, combat reconnaissance vehicles and infantry fighting vehicles have either not been undertaken or not been disclosed. This adds to the limited transparency around projects with sovereign status.

The frigate study is a welcome addition for its exploration of the economic benefits involved. But, for public policy purposes, its estimates of economic impact have significant limitations: not all major sources of potential benefit are included, and the economic costs of the project aren’t covered at all. Moreover, two items of data critical to a comprehensive form of impact analysis—the level of targeted Australian content and any price premium for preferring domestic over foreign supply—aren’t referenced.

Economic costs include the fact that projects ultimately need to be paid for through higher taxes or reductions in other forms of government expenditure. They also include projects potentially drawing on resources—like skilled labour—that are in short supply and that other projects and other industries might have used to create economic benefits of their own.

As the paper explains, broader evidence suggests that even defence capital equipment projects with price premiums of 15–20% may not necessarily have clear, positive outcomes in terms of their national economic and perhaps even military-strategic impacts, especially if less than half of the inputs those projects require are produced in-country.

The same evidence also suggests that, with price premiums having the potential to reduce what the defence budget can accommodate, projects with high premiums might be better described as examples of nation-building than of defence industrial sovereignty—when there are probably more effective and efficient avenues for building the nation’s economy.

Unfortunately, publicly available data provides limited insight into where the price premiums for vessels and vehicles might lie. However, there’s no shortage of factors, described in the report, which suggest that premiums are considerably higher than initial impressions indicate.

Another factor complicating the assessment of economic impact is the absence of a clear, public explanation of the path to economic growth underpinning the government’s approach to project development. That makes it difficult to determine exactly what economic factors are involved and how they’re expected to interact.

Stripped of its paraphernalia, the relevant theory of growth appears to condense to the following: exports eventually facilitate the cost-efficient design, development and production of most of the complex systems, components, materials and services going into the equipment Australian industry delivers to Defence and to overseas customers, and that investment results in significant spillovers of new knowledge to provide an additional—and perhaps even primary—impetus for ‘jobs and growth’ by supporting productivity improvement in other areas of the economy. So far, so good.

Nonetheless, the theory’s preconditions for success and their risks have yet to be enunciated clearly at a policy or a project level. Recent history suggests that banking export and spillover credits for ships and vehicles, especially for projects that have barely commenced, carries an unusually high degree of risk.

With so many pivotal issues still not resolved or revealed, it’s difficult to assess the economic impact of defence capital equipment projects based on available vessel or vehicle data. That by itself is a reason for concern.

Given the technical and even logistical complexities involved, perhaps the only way to rectify the problem—and to establish a reliable set of economic principles for the future—is to refer military equipment procurement to the Productivity Commission for review.

That’s something for defence policymakers to decide. In assessing the issue, the department might consider that it’s been 25 years since the last dedicated Productivity Commission inquiry. Much has changed since then, including a shift in defence industry policy over the past three years towards higher levels of industry protection and large increases in both endorsed and potential investment in equipment.