When the promise was made to increase defence spending to 2% of GDP (both by the government and opposition) neither would have had a clue what sort of defence force would be affordable with that much money. Last year, we had a look at what 2% of GDP in the decade commencing 2023-24 might allow. Given that 2% of GDP is a movable feast, we redo that calculation again this year. In this section, we again assume the nominal GDP growth rates from 2014 National Commission of Audit for the years beyond 2018-19. In the next section, we examine how volatility in economic growth and foreign exchange rates could change the effective buying power available to Defence.
Figure 3.6 shows the budgeted (2015-16 to 2018-19) and projected (2019-20 to 2023-14) shares of the defence budget going to personnel, capital investment and operating costs. For the period beyond 2018-19, personnel and operating costs have been projected out as explained below, while capital investment is estimated as the simple residual (= budget –
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personnel costs –operating costs). This makes sense because personnel and operating costs are effectively a consequence of the size and shape of the ADF, whereas the level of capital investment is discretionary on a year-to-year basis.
Consistent with established per-capita trends in personnel expenses (see Chapter 2 of this Brief) and assuming that the ADF does not grow past 59,300 after 2018-19, personnel costs have been assumed to grow at 2.5% p.a. real (5% nominal) beyond the Forward Estimates.
Similarly, operating costs are assumed to grow at 3.0% p.a. real (5.5% nominal) over the same period consistent with budgeted growth over the Forward Estimates last year. We have not used this year’s figure because, as explained above, it curiously predicts little growth. In any case, if we used a smaller rate for the increase in operating costs, the resulting growth in capital investment would be even more extraordinary than shown in Figure 3.6.
Figure 3.6: Budgeted, estimated and projected costs 2014-15 to 2023-24
Source: DAR, PBS, PAES and ASPI analysis
If achieved, it would mean that capital investment over the decade commencing 2014-15 would amount to $124 billion, compared with a mere $67 billion over the preceding decade measured in 2015-16 dollars. Note that the scale of spending over the forthcoming decade has increased from last year’s estimate ($112 billion). That’s because personnel and operating costs are now budgeted to grow more slowly over the forward estimates.
What about the years beyond 2023-24? Presumably the government doesn’t plan to increase defence spending to 2% of GDP and then let it fall? Figure 3.7 plots the historical and projected share of the defence budget out to 2033-34 assuming that the labour component of the ADF remains static post 2018-19. For GDP growth past 2023-24, we’ve used the 2.8% real GDP growth figure forecast in Treasury’s 2015 Intergenerational Report and assumed that the GDP deflator averages out to 2.5% over time in correspondence with the CPI, hence nominal annual GDP growth of 5.3%.
6 8 10 12 14 16 18
billion 2015-16 $ (billion)
Personnel Capital Operating
Operating Costs 3.0% real growth 2019-10 to 2023-24
Personnel Costs 2.5% real growth 2019-20 to 2023-24
Capital Investment 7.4% real growth 2019-20 to 2023-24
Budget Estimates
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Beyond 2023-24, the capital component of the budget levels off because personnel and operating cost growth (almost) match GDP growth. Nevertheless, the subsequent decade would see an eye watering further $197 billion in 2015-16 dollars go to capital investment.
Given that we’ve managed to recapitalise a good share of the ADF during the 15 years immediately past, it’s pretty clear that such high levels of capital investment are unnecessary for a defence force of the size presently planned.
Figure 3.7: A mountain of equipment
Source: DAR, 2013-14 PAES, 2015-16 PBS and ASPI analysis
One way to make sense of the situation outlined above would be if there was a plan to expand the size of the defence force. By doing so, personnel and operating costs would rise and less money would be left for capital investment. In theory at least, there exists a larger ADF for which 2% of GDP in 2023-24 and beyond would bring personnel, operating and investment spending into something like a sustainable balance. (In practice, there’ll never be a ‘steady state’ apportionment of capital, personnel and operating costs because they each have slightly different intrinsic growth rates—notwithstanding the fluke result above).
However, to date, the government hasn’t discussed any plans for expanding the size of the force. To the contrary, it has been hedging previous promises—most especially regarding 12 submarines. Perhaps they are still coming to grips with what they’ve promised.
The situation shouldn’t come as a surprise. The promise of raising defence spending to 2% of GDP within ten years wasn’t the result of detailed financial analysis. Rather, it was an artefact of our decimal counting system (hence the decade) and the unofficial NATO benchmark of 2% of GDP. A benchmark that is much more often honoured in the breach than in observance—in 2014 only five of 25 European NATO countries reached that level.
It would have been an extraordinary coincidence if spending 2% of GDP in 2023-24 and beyond was consistent with an ADF of the size and shape currently planned. It was always overwhelmingly likely there would be either too little or too much money.
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Financial Crisis Impact
2% of GDP target date
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I suspect that the estimate calculated above overestimates the amount of money available for capital investment. Not because of any omission or systematic error in the calculation, but because Defence’s anticipated reduction in personnel and operating cost will not come about. Instead, personnel and operating costs will grow over the next four years and leave less money for investment than projected above. Nevertheless, even taking account of Defence’s overoptimism; it looks as though there will be a massive chunk of money available for capital investment in the years ahead.
With this in mind, there are two things to expect from the forthcoming White Paper. First, the size of the force will grow. An extra battalion or two to crew the new LHD amphibious vessels would help bring things into balance, as would an expansion of the surface combatant fleet to meet South Australian demands for a continuous build program. Such possibilities aren’t to be discounted.
Second, with so much money available, we should expect to see proposals of diminishing marginal worth brought forward (see preceding paragraph for examples). Even if
prioritisation is done properly, every new initiative enabled by extra funding will be of less value than existing ones. But 2% of GDP will enable some especially marginal propositions to be seriously considered. By so greatly loosening the fiscal disciplines on Defence, the
challenge for the government will be to contain the potential for far-reaching waste.
It looks as though we’re firmly into the ‘tail wagging the dog territory’ wherein an arbitrary number is set to unleash a previously unplanned expansion of the ADF at enormous cost whithout consideration of what it will add to Australia’s security beyond sending a message to allies and friends.
In case I’ve failed to be clear; funding Defence as a proportion of GDP is poor policy. As the national commission of audit observed:
The Commission considers a sensible way of approaching this task is for the Government to use the White Paper process to consider the strategic risks and associated capability requirements that different levels of funding can address. As part of this process, the Government should also assess the balance of strategic and fiscal priorities and how this compares with the 2 per cent of GDP spending
commitment. This should result in a better balance between risk and resourcing – and implies a force structure focused on the most important threats.
But if we must plan on the basis of 2% of GDP, there are some technical issues that need to be appreciated and managed.