Cuts, costs and kit: the economics of the defence review

Thursday, July 22, 2010

Deep cuts in the Strategic Defence and Security Review were always inevitable, regardless of the politics of the government, as Professor Keith Hartley, emeritus professor of economics at The University of York, tells editor Joel Shenton...

The Strategic Defence and Security Review is under way, and a good sense of some of the 'pain' of the inevitable cuts seems to be finding its way into the public domain. Whitehall insiders are briefing journalists regularly on some of the key options being considered, and anyone with an interest in defence is beginning to develop an outline, albeit sketchy, of the implications.

Regardless of the noise generated by the ongoing debate, some things are starting to become clear. The Defence Secretary Liam Fox has described the review as a "full-scale strategic review with the absolute mother of horrors of a spending review on its back". By all accounts this is no exaggeration. The Ministry of Defence will be aiming to simultaneously set budgets for the future while exploring the options to save money in replacing the UK's strategic nuclear deterrent. At the same time, the heads of the armed forces and the politicians will be trying to define Britain's place on the world stage and strategic capability within an already overheated equipment programme and a current budget that is regularly exceeded.

Keith Hartley, emeritus professor of economics at the University of York, believes that when the review is completed, a reduction in the size of Britain's armed forces is inevitable, particularly as the strategic and financial value of many 'big ticket' items – including Trident, the aircraft carriers and the joint strike fighters – is subject to regular debate in public.

"Whilst the armed forces might have this wonderful shopping list of all the aircraft, warships and tanks that they would like, inevitably there are budget constraints," says Hartley. "Therefore the starting point is the obvious one, which is that something has to go."

"We need to start from the fact that our forces have been overcommitted, underfunded and that within that our equipment budget has been massively, massively underfunded," he says. "What I would like to see is for them to go back to fundamentals and look at the case for defence, look at the costs and benefits of our world military role.

"The UK's defence share of GDP is about 2.2 per cent at the moment. Compare that with the European NATO average or with other comparator nations like Germany and Italy. Germany and Italy spend about 1.4 per cent of their GDP on defence. The European NATO average at the moment is about 1.7 per cent. So as a ballpark figure, if you compare the percentage of GDP we're spending on defence with those comparators, then the costs of our world role are about something in the region of 0.5 per cent to getting on for 1 per cent of GDP. In terms of pounds it's between £9bn and £16bn based on the 2009 defence budget.

"That's the cost of being a world power; it is not cheap."

The billions spent on maintaining the UK's world military role bring some considerable benefits, says Hartley, and many of them are unlikely to be up for discussion.

"We have a major role in the UN Security Council, we're number two in NATO and we're clearly a major player in the G8 and G20 group of nations," he says. "We get other economic benefits such as the UK/US special relationship, which provides certain defence capabilities at a lower cost than if the UK had gone alone - such as the provision of missiles for the strategic nuclear deterrent and presumably for any replacement.

"We have other economic benefits in the form of, for example, BAE's central involvement in the Joint Strike Fighter programme. We've got an agreement that we'll have ten per cent of that total business. Plus, of course, the UK's BAE and Rolls-Royce are major players in the defence market."

"I still think there's a case for debating the world role, but I don't think we'll have a serious discussion of that. I think it'll be assumed that we maintain our world military role."

Whatever happens, Hartley is sure that current size and shape of the armed forces will not stay as it is. The cuts are likely to be spread across the forces, and the end result - with the MoD being asked to prepare plans for budget cuts of between 10 and 20 per cent despite regularly exceeding its current budget - will be "a clear reduction in our defence capabilities", he says.

"At the moment we have a commitment to being able to fight one large-scale conflict in a coalition, largely with America, or to fight up to three small-to-medium-scale conflicts," he says. "I think we'll change that. I suspect we'll go down to a capability of fighting two small-to-medium-scale conflicts.

"We're going to have further reductions in our forces across the board: army, navy and air force; perhaps not so much the army so long as we remain in Afghanistan. Longer term, over the next four or five years, I see further reductions in the number of our military personnel. We have about 190,000 at the moment and I see numbers falling to around 150,000."

Among those cuts, Hartley believes that British bases in Germany may well be closed, something that Defence Secretary Liam Fox discussed in 2009 as Shadow Defence Minister.

"We clearly don't need 20,000 troops in Germany," says Hartley. "It might well be that over the long-term the equivalent of those 20,000 troops could be abolished from the total size of the UK armed forces and we might keep a token force in Germany."

As well as personnel, it is expected that there will be cuts in equipment orders too, with fast jets and warships likely to face the axe. With the Queen Elizabeth class carrier programme, Hartley sees a difficulty in making cuts to two incredibly complex and expensive procurements.

"The problem with what should go is that as an outsider I don't know the contractual commitments," he says. "What I do know is that when you cancel a programme there are cancellation costs. It might well be that we're already down the road, as people say, with the carrier programme; that we are committed to taking one. I would look critically at whether we need two.

"I can't understand the argument that we need to buy two to continuously deploy one. If the navy is saying that we've got to spend £6bn at the moment on just buying the two carriers to maintain one at sea then they can only be at sea on average six months of the year. I think that commitment needs looking at far more critically."

There is evidence to suggest that the contractual details and negotiations which cannot be made public are where many of the MoD's problems lie, and the secretive nature of the deals done could well be a breeding ground for poor business decisions, greed or even corruption on either side of the procurement equation.

At the beginning of 2010, acquisition reform was a hot topic, with promises made to change the way the MoD does business and make it a more 'intelligent customer'. Of course, whether or not acquisition reform is a success is difficult for outsiders to benchmark. The Conservative party, now in coalition with the Liberal Democrats, were promising to implement reforms suggested by Sir Bernard Gray in his damning 2009 report on MoD acquisition, and Gray's analysis of the ministry's acquisition process had even been adapted, almost adopted, by the previous Labour government.

"I agree with Gray that there is basically an optimism bias in the whole procurement situation," says Hartley. "This is optimism of industry, optimism of civil servants and optimism in the armed forces; all of whom are desperate to get he latest piece of kit.

"Air marshals love fast jets, admirals love aircraft carriers and generals love high-technology tanks - and they become very optimistic in wanting these in terms of performance requirements. Industry has every incentive to go along with that optimism bias; it wants the contracts. MoD doesn't address the issues because it doesn't have the constraints placed upon it. So MoD has gone along with this and funded it by saying 'we'll put everything in the forward equipment programme, we're not going to make the tough decisions. Let politicians do that.'

"And politicians have no incentives, they don't want to make the tough decisions and cancel an aircraft carrier which means job losses on the Clyde or at Barrow or at Portsmouth.

"In the private sector you couldn't' have that. In the private sector the ultimate sanction is that firms will go bust."

In the Ministry of Defence, Hartley says, the general approach is to go for reduced numbers for the same outlay or simply to delay programmes. The National Audit Office (NAO) have repeatedly criticised these methods, which can add hundreds of millions of pounds to the cost of the already expensive procurement process.

"The NAO reports are always saying 'the programme is late and the programme is over cost: criticise MoD'", says Hartley. "What they might be doing is saying to MoD: 'look, you're making a damn good job of this. You've got an impossible situation. You've got to manage this ambitious forward equipment programme and the government's not giving you enough money to do it.

"It needs someone in MoD, effectively the secretary of state, to say "we can't afford all this. Either something has to go or we've got to put far more money into defence." This is where the strategic defence review may be able to help, by making some unpopular cuts under the twin banners of cost-cutting and strategic changes to force structures."

As if the budget cuts of up to 20 per cent weren't enough, they are coming in the wake of reported budgetary 'black hole' that already required the ministry to tighten its financial belt.

"It was anywhere between £6bn, £36bn and there was even a Public Accounts Committee report that said it could be as high as £80bn," says Hartley. "I don't think it is as high as £80bn, but I think there will always be that sort of overrun and that sort of deficit."

Hartley says that certain big procurement decisions would have little affect on the currently stretched budgets. JSF and the carriers may not even be ready until well into the next parliament in 2015, and since it is unlikely that the replacement for the nuclear deterrent would be ordered before 2015, cancellation of that would have no impact on the current budget either.

However, he says that halving the order for joint strike fighter jets and ordering just one of the carriers could potentially save in the order of £10bn. This would make a serious dent in any budget 'black hole'.

"I would think seriously about halving the number [of joint strike fighters], to about 70," says Hartley. "It might well be that we go for a mix of conventional takeoff and STOVL (Short Take-Off and Vertical Landing) variants. If they are in the order of £80m per copy, you've saved over £5bn there on that programme. You'll save another £5bn if you don't buy the second carrier."

Even if the hard choices aren't made on such high-profile programmes like JSF and the carriers, Hartley believes that the ongoing review and accompanying structural change could be as significant as the downsizing seen in the early 1990s.

"The last major, really serious defence review we had was at the end of the Cold War, and that led to a massive step change downwards in the size of our defence spending," says Hartley. "We might be having the equivalent now of a further downward step change."

"It's nothing to do with the political composition of the government, left-wing, right-wing or whatever; these are simply cost pressures; and it's the nature of the sort of technology we're acquiring. Inevitably, armed forces have got to be equipped to fight a whole range of conflicts, some of which are unknown and unknowable. The future is characterised by massive uncertainties. The armed forces have got to provide forces that will effectively lead these unforeseen, unknown and unknowable contingencies."