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The case for naval shipbuilding: opportunities, costs and benefits

Posted By on April 20, 2015 @ 06:00

[1]Despite press [2] and broadcast [3] reporting that largely focused on the omission of submarines [3], the RAND report [4] on naval shipbuilding in Australia is a valuable contribution to the discussion of this important public policy issue. No doubt it would’ve been better if the analysis had included submarines as an addition to the baseline surface shipbuilding it examines, but it still answers some important questions.

Perhaps most importantly, it provides a solid estimate of the premium the Australian taxpayer currently pays for local construction, and what the ‘best case’ figure might be in the future. The headline answer for the current premium is 30–40% for ships built entirely in Australia, and less for ships only partly built here. The former figure isn’t surprising, and agrees with estimates I’ve made in the past [5].

Allan Behm complained on The Strategist last week [6] that there’s too much focus on the economic aspects of shipbuilding, and not enough on the strategic benefits. I’m not sure I share that view, for two reasons. First, and as my writings over several years show, I’m not at all persuaded by arguments about the strategic value of a shipbuilding industry based on its capacity to repair, maintain and upgrade vessels built here. It seems to me that you could substitute ‘ship’ for ‘aircraft’ in the argument and the case would be the same—except for the fact that Australia’s indigenous military aircraft industry disappeared years ago.

Second, each defence dollar can only be spent once, so there’s necessarily an opportunity cost if we decide to spend more on naval shipbuilding. Instead, the correct approach is to look at all of the costs (including those opportunity costs) and benefits (economic and strategic) that accrue, and then make a judgement about the net value of the industry.

To make well-informed and balanced judgements, it’s important not to under- or overstate costs and benefits. The direct and indirect economic benefits of naval shipbuilding [7] (PDF) are often cited as a reason to maintain the industry. But RAND looked at the economic benefits of shipbuilding, and found them to be ‘localized to a large degree’ (which, I’d add, is why state governments value them) and notes that it’s ‘unrealistic to expect that shipbuilders will produce significant favourable spin-offs and spillovers’. At best there’s conditional support from RAND for the economic considerations for local shipbuilding:

‘[t]he economic benefits of a domestic naval shipbuilding industry are unclear and depend on broader economic conditions.’

Given that the best case result will still see us pay a premium for local construction, the benefits will probably have to be found elsewhere. So I can’t agree with most of Allan Behm’s judgements. Where I think there might be some value in keeping a naval shipbuilding industry is in maintaining some diversity in the economy, and in providing a modestly-sized ‘wildlife refuge’ for skilled labour in times of economic downturn.

To see how that might work, let’s start with the RAND comment above. The reason that the net economic value of shipbuilding depends on the broader economy is simply that there are times when skilled labourers, production engineers and project managers are more productively employed elsewhere. The Air Warfare Destroyer project was born into such an environment—with the minerals boom in full swing (and the price of iron ore heading upwards towards a peak of well over US$150 per tonne [8]), the impact of diverting a large number of people with skills applicable to the resource sector was amplified.

But that was then and this is now, with an iron ore price under US$50 per tonne and trending lower [9]. With a commensurate slowdown in investment in further mineral prospecting and exploitation, the opportunity cost is lower. Indeed, there might be some long-term benefit in having a pool of skilled people employed at a time when the resources sector is shedding jobs [10].

As I’ve probably just amply demonstrated, I’m not an economist. The business case would need to be examined carefully and objectively. I’m not sure how you value sectoral diversity, but my suspicion is that it wouldn’t be a big selling point—Australia’s economic comparative advantages are in areas well-removed from heavy engineering. That’s not a bad thing. Although we rank below 50th in economic complexity index [11], we rank highly on GDP per capita, which means we’re doing something right.

But it’s obvious that the case for a naval shipbuilding industry would be stronger if (a) the premium could be minimised and (b) it didn’t detract too much from the high value-adding part of the economy. RAND provides a plan that could achieve those outcomes. Depending on how it was implemented, the recommended ‘steady build’ approach might produce a workforce of around 1,500 people, compared to the peak workforce of 2,500 a few years ago. And the premium could be managed downwards, but only by ‘radical changes [to acquisition practices]… focusing on cost-effectiveness’.

I’d say that they’re necessary conditions for improving the business case for local naval shipbuilding. A more detailed analysis is required to see if they’re sufficient. But at least we now know a lot more.



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URLs in this post:

[1] Image: http://www.aspistrategist.org.au/wp-content/uploads/2015/04/4589838_68ffe531c8_z1.jpg

[2] press: http://www.smh.com.au/federal-politics/political-news/major-local-shipbuilding-report-excludes-submarine-costings-20150416-1mmed1.html

[3] broadcast: http://www.abc.net.au/pm/content/2015/s4217916.htm

[4] RAND report: http://www.rand.org/pubs/research_reports/RR1093.html

[5] agrees with estimates I’ve made in the past: http://www.lowyinterpreter.org/post/2009/10/30/AWD-Three-for-the-price-of-four.aspx

[6] on The Strategist last week: http://www.aspistrategist.org.au/naval-shipbuilding-thinking-beyond-the-cost-curve/

[7] economic benefits of naval shipbuilding: http://www.defencesa.com/upload/media-centre/publications/cor/3304/NavalShipbuildingPaperFinalLoRes.pdf

[8] heading upwards towards a peak of well over US$150 per tonne: http://www.indexmundi.com/commodities/?commodity=iron-ore&months=120

[9] under US$50 per tonne and trending lower: http://www.smh.com.au/business/markets/iron-ore-price-slips-back-below-us50-per-tonne-20150416-1mmx4h.html

[10] is shedding jobs: http://www.smh.com.au/business/the-economy/mining-companies-shedding-jobs-by-the-thousands-20150320-1m35zx.html

[11] economic complexity index: http://en.wikipedia.org/wiki/List_of_countries_by_economic_complexity

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