Submarines: reader response
18 Nov 2014|

A Collins class submarine in dock at the Australian Submarine Corporation facility, Adelaide.Henry Ergas and Mark Thomson criticise, on a number of counts, the paper on Economic analysis of Australia’s future submarine program prepared by the South Australian Economic Development Board. Each count requires detailed rebuttal, but there’s space for only a brief response here.

Ergas and Thomson state that the paper assumes that the cost would be the same (AUD$20bn) whether built in Australia or overseas. In fact, that conclusion was the result of gaining frank opinions from submarine construction experts from several countries. All of those experts were in a position to assess the international commercial realities of the construction task. The model used a US$0.92 exchange rate but also included a ‘purchasing-power-parity’ exchange rate of US$0.73, which when used, yielded an even stronger case for building in Australia: a $26.7bn benefit compared with $21bn.

The authors make much of reported errors and cost blowouts on Australian defence construction projects. Only those cost problems relating to the Collins class submarines have been assessed in the analysis. Evidence submitted to the Commonwealth Senate Economics References Committee—and reproduced in the Coles and other reports—point to administrative errors on the part of the Defence Materiel Organisation and the Navy that had a greater, but less widely publicised, impact on costs and outcomes than errors by ASC.

Assuming the identified errors are corrected, Australia has ‘the smarts’ to build and maintain submarines to a standard and cost comparable with its competitors. It’ll certainly have to partner with firms in other countries for design and to gain access to the weapon systems and new technologies it wants to deploy in the vessels but, as in the case of the Collins class, it retains the ability to coordinate the project and gain skills in installing and maintaining that technology. That there’d be gains in knowledge spillovers, employment and firm development is beyond question.

Ergas and Thomson refer to ‘agency problems’ of having a national monopoly supplier—which do exist, but there are numerous ways of constraining them to levels that make a national monopolist the most efficient and effective supply option. In this case, ‘efficient and effective’ includes addressing the problem that other countries with defence monopolists face: ensuring existence of on-shore capabilities to respond to unforeseen challenges in the event of military attack.

The question of need for adequate on-shore capability arises again in the authors’ criticism of the assumption that what the report describes as ‘heavy maintenance’ (HM) must be done at the location of construction. HM includes replacing and upgrading to address new technology that inevitably becomes available to Australia and its potential enemies over the life of the new submarines. They clearly don’t understand that a major cost of such HM is maintaining the capability to do it. That includes a detailed understanding of the new and existing technology—and since we don’t know, in advance, what elements will need upgrading, we must maintain capability in all aspects of the submarines built.

Building and maintaining such capability is also a major cost of the construction phase and the most effective way to do that is to have the relevant experts involved in design and construction—so it doesn’t make sense to separate the HM function geographically. The logic is all the more compelling since the total cost of HM is only 21% of the total $20bn cost as the cost of maintaining capability is absorbed by the construction phase. It’d be significantly more otherwise.

In addition, it’s worth reflecting on Australia’s requirement to be the ‘parent navy’ for this new class of submarines since we’ll be the only user of this class—which is different from buying an off-the-shelf product like a US fighter plane. The parent navy role entails the full design, development, test and evaluation effort for both the construction phase of the class and for the class’ operational life, some 40-50 years all in all. A parent navy must understand all emerging issues, set aims and objectives, pay for changes, and ensure that design certification is assured and design intent preserved. Failure to do this will result in the mess that brought about the Coles Review. A parent navy role can only be taken on if the submarine is built in Australia.

Finally, most OECD countries have come to realise that they can’t remain prosperous without a thriving manufacturing sector with its linked service sector. For that reason, most have large programs, including defence procurement, to stimulate innovation and thereby to provide a competitive edge to their industries. Eliasson estimates, for example, that between 1982 and 2007, the Gripen multi-role combat aircraft project in Sweden generated at least $350bn Swedish Krona (SEK) in additional production from a government investment with a 26-year opportunity cost (at 4% real discount rate) of SEK$132bn. That’s a turnover multiplier of 2.6 times the investment. Most of these benefits come from ‘spillovers’ in the form of new knowledge. In the South Australian case, analysts used a conservative knowledge spillover multiplier of 0.35. It’s safe to assume that almost all such spillovers will be lost to Australia if the submarines are built overseas.

Göran Roos is professor of business and strategic design at Swinburne University of Technology and chairs the South Australian government’s Advanced Manufacturing Council. Image courtesy of Wikimedia Commons.