UK Defence Spending. Professor Keith Hartley Defence Research Institute Universities of Lancaster and York

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1 UK Defence Spending Professor Keith Hartley Defence Research Institute Universities of Lancaster and York Introduction Defence economics stresses that difficult choices in defence policy cannot be avoided. Usually, the Armed Forces have a shopping list of requirements for new equipment, personnel and facilities which greatly exceeds the annual defence budget. Not all their demands can be met so the limited defence budget is allocated on the basis of priorities. Normally, this priority system can accommodate the excess demand by various techniques and queuing systems. Every year there is something for each Service ( a fair shares allocation) and a promise of a priority for funding in future years (the Buggins Turn principle). For example, this year the RAF will receive its Eurofighters; next in turn, the Navy will receive its carriers and their aircraft; after which the Army will receive its new communications system. Continued pressures on defence budgets can also be handled by shifting the new equipment programme to the right; by cancelling some projects; by stretching-out new programmes; by economising on training and exercises; and by seeking yet more efficiency savings. The record of UK defence spending can be used to identify these pressures on the budget and how the problems have been solved. The record UK defence expenditure is determined by its ability and willingness to pay for defence, where willingness to pay reflects such factors as potential threats to the nation, its membership of NATO its role as a world power and the willingness to sacrifice alternative civil expenditures (eg guns versus social welfare spending). Once the size of the defence budget has been determined with its inevitable sacrifice of civil goods and services (eg schools; hospitals), further choices are required to select the distribution of the budget between equipment and personnel, between each of the Armed Forces and the geographical allocation between the UK, Europe and the rest of the world. The results of some of theses defence choices are shown in Table 1. Table 1 Here Table 1 shows the record of UK defence spending over the 20 years 1980/81 to 2000/01. This period covers both a peak in defence spending in 1985/86 (the end of the UKs commitment to NATO to increase its defence spending by 3% per annum) and the disarmament of the 1990s reflecting the end of the Cold War (ie. changing threats). Even before the end of the Cold War in 1990, UK defence spending in real terms declined by some 10%, leading the House of Commons Defence Committee to warn of a defence review by stealth (HCP 37-1, 1985, pxli). During the 1990s, following the end of the Cold War, real

2 defence spending fell by almost 25%, the numbers of military personnel declined by over 30%, the share of the budget for personnel also fell, but the share of equipment spending rose from almost 40% to some 44%. Options for Change resulted in a reduction in UK regular forces of over the three years 1992 to 1995 (including almost redundancies), whilst the Defence Costs Studies led to a further loss of military personnel over the two years 1995 to 1997 (including almost redundancies: MoD, 2000, p 30). Amongst the Armed Forces, the RAF experienced the greatest percentage cuts, with a reduction of almost 40% in personnel between 1990/91 and 2000/01, compared with cuts of 32% for the Navy and 28% for the Army. Questions arise as to whether these different percentage cuts in personnel reflect the success or failure of each of the Services to maintain their relative budget positions and to protect their major equipment projects, and/or whether they indicate the extent of overmanning and inefficiency (eg. in support areas). In this context, one international comparative study concluded that in 1993, the RAF employed 49% more manpower per equivalent combat aircraft compared with the 15-nation average (Owen,1994). International comparisons are also valuable in assessing the UKs defence burden, especially when compared with its NATO allies. Table 2 shows defence burdens for a sample of countries, including NATO averages for Europe and in Total. Whilst defence burdens have declined over the period 1980 to 2000, the reductions were generally greater in the 1990s following the end of the Cold War. It is also evident that the UK defence burden has continued to be greater than the average for NATO Europe and for France, Germany and Italy, where these countries are amongst the UKs major international competitors. Two implications follow. First, the UKs relatively higher burden reflects its role as a world power and a comparison with the average for NATO Europe provides a crude indication of the costs of being a world power. Second, the relatively high defence burden borne by the USA compared with NATO Europe is the focal point for debates about burden-sharing within NATO. However, the US burden figures are misleading since its defence effort is for the defence of the US continent and the Pacific and not solely for NATO. Moreover, there are further burden-sharing issues amongst the European members of NATO (cf. the UK and Germany: Hartley and Sandler, 1999). Future Problems Table 2 Here Defence is increasingly expensive. Over the 20 years 1980/81 to 2000/01, real defence spending for each member of the Armed Forces has increased by 26%, equivalent to an annual average increase of 1.3% per year (see Table 3). Such increases reflect the rising costs of both equipment and personnel. Typically, the real unit costs of equipment have risen by about 10% per annum whilst the military salary has risen faster than movements in the retail prices index (eg the military salary index was 180 in 1999 compared with the RPI of some 150 with a base year of 1988/89: MoD, 2000, p 46). Whilst these rising unit costs reflect higher productivity, their impact on a constant or declining defence budget means smaller forces (smaller but better equipped forces). Consider one possible scenario for 2015 which marks the end of the 1998 Strategic Defence Review planning period. Assuming real per capita defence spending continues to rise at its past trend rate and the

3 real defence budget increases at an average rate of 0.5% per year, then by 2015, the UK will have a regular force of almost personnel. Based on current proportions, this might mean an Army of personnel, an RAF of personnel and a Navy of personnel. Of course, the continued search for a peace dividend might mean little, if any, increase in real defence spending, so that the numbers of military personnel will fall even further. For example, a constant real defence budget at its 2000/01 level with rising unit costs might mean a UK regular force of under by 2015; but there is no reason why the current distribution of personnel between the three Armed Forces should be maintained in the future (eg. the Army might take a larger share of total UK military personnel). The continued search for a peace dividend reflected in society s preference for greater social welfare spending will create downward pressure on the defence budget. Rising costs will lead to pressures from the Armed Forces to import equipment which is shown to be cheaper, faster and better. Table 3 shows that the import share of UK equipment spending rose substantially in the 1990s. Rising imports together with disarmament has resulted in job losses in the UK defence industry. During the 1990s, employment in the UK defence industrial base fell by almost 40%. Indeed, the reductions in real defence spending and the associated fall in military personnel, together with the job losses in the UK defence industry during the 1990s, provide an indication of the magnitude of the resources released from the military-industrial complex following the end of the Cold War (although it does not follow that all these resources were subsequently re-employed in the civilian economy: see Tables 1 and 3). Table 3 Here A further indication of the pressures on the defence budget is provided in Table 4 which shows the future UK major equipment projects with in-service dates between 2002 and The Table shows the magnitude of the costs for some of the new equipment programmes (eg. Eurofighter; the Future Strategic Tanker Aircraft; the carrier programme comprising the vessel and its aircraft) and provides a broad indication of the total costs of new projects over the period to The Table does not show the years of peak expenditure for each project (these are not always in the public domain), nor does it show some of the costlier Public Private Partnership Projects (eg military flying training) and some data are for development only. The new projects in Table 4 are forecast to cost some 78 billion. Air systems are expensive, accounting for 72% of forecast expenditure with sea systems responsible for a further 20% of total new equipment spending. These figures confirm that the RAF and the Navy are the capital-intensive forces, compared with the labour-intensive Army which accounts for under 10% of the forecast equipment expenditure. Table 4 Here The scale of future equipment spending appears greater than in recent years. In its 1999 Major Projects Report, the National Audit Office (NAO) estimated that the top 25 equipment projects would cost 37.6 billion and in its 2000 Report it estimated that the top 20 projects would cost 44.7 billion (NAO, 1999; 2000). The 22 projects shown in Table 4 involve estimated future expenditure of some 65 billion (ie. allowing for expenditure already incurred and including a 17 year lease acquisition costs only for the Future Strategic Tanker). Moreover, as the NAO Reports have recognised, estimated costs increase and in-

4 service dates slip, both of which result in even greater pressures on a limited defence budget (eg. the costs of running-on older equipment). Such sizeable future equipment spending plans create a major defence budget management problem. A successful Smart Procurement Initiative will help, but the official forecasts claim cost savings from the policy of some 2 billion over the period 1998 to 2008 (equivalent to an annual average saving of some 200 million: SDR1998, p 42). Alternatively, Table 4 shows the scope for budget savings from cancelling one or more major equipment programmes. Future Prospects Traditionally, when confronted with difficult defence choices and a reluctance to raise defence spending, UK governments have responded by seeking efficiency improvements, by resorting to equal misery and the fudge-it option and, in the last resort, a major defence review. SDR aimed to achieve efficiency savings of 3% per year from 1998 to 2002, additional to the efficiency savings already achieved of almost 5 billion over the period 1988 to Reservations have been expressed as to whether these efficiency savings have been, and can be, achieved without a significant reduction in defence capability. The Defence Committee has expressed its reservations: Overall, we conclude that the condition of the defence budget is sufficiently poor to give rise to serious concern. The cumulative evidence of cancelled exercises, delayed equipment programmes and of resources apparently insufficient to reverse the problems of overstretch and undermanning suggest that if the wheels have not yet come off the SDR, they are certainly beginning to wobble alarmingly (HCP 158, 2000, plxi). A continuing defence funding problem will eventually require radical solutions. SDR II needs to return to some of the issues which were accepted by the original SDR. These include a critical evaluation of the costs and benefits of the UKs role as a world power with the associated military capabilities, and the purpose and costs of some Army personnel based in Germany (including the benefits from the new members of NATO in contributing to defence in central Europe). Defence economics also stresses the principle of substitution which shows that there are alternative methods of achieving defence and protection. For example, the UKs major new equipment programme might be expected to lead to labour-savings and the possibility of substitution between capital-intensive air forces and labour-intensive armies. The result of such substitutions would mean radical changes in the relative size of each of the Armed Forces. The substitution principle might also mean foreign equipment replacing UK equipment where it is cheaper, available faster and of proven quality. This might mean the UK defence industry becoming more involved in international collaboration with the US defence industry (cf. UK involvement in the US Joint Strike Fighter). There are also lessons to be learned from the continued application of experience from the private sector. Resource Accounting and Budgeting (RAB) and Public Private Partnerships (PPP) are current examples. But the adoption of private sector management methods will not guarantee improved efficiency. Whilst such methods help, they do not make efficient decisions. The private sector is characterised by entrepreneurs seeking profits in a world of uncertainty where they are subject to competition and rivalry and to the threat of bankruptcy and take-over from the capital market. Such market features are absent from the Armed Forces. For example, efforts to achieve efficiency savings from RAB will depend upon military commanders having control over their asset use, the incentive to dispose of surplus assets and substitute between assets, including substitutions between physical and human capital; and a successful RAB system requires reliable

5 output measures related to the end-purpose of defence. In the longer-term, the UK and other European Union (EU) states might regard independence and national defence as too costly. The EU is characterised by national defence industries with duplication of costly R&D projects and small-scale output based on their national orders. Similarly, each EU nation has an independent Army, Navy and Air Force involving massive duplication of Defence Ministries, training and logistics, with each nation having only limited buying-power in equipment markets (Sandler and Hartley, 1999). In contrast, the US model is based on a large national market with a single US Army, Air Force and Navy. The EU equivalent would require the creation of a Single European Market for defence procurement and the eventual creation of a single EU Army, Navy and Air Force. Within such an arrangement each nation would specialise by comparative advantage. However, it is recognised that economically-attractive solutions are often politically unattractive. Conclusion The record of UK defence spending reflects the outcome of difficult choices. The future prospects reinforce the continuing necessity for such difficult choices for defence policy-makers. Something will have to go and the question is what goes? Defence economists can contribute to this debate by identifying the costs and benefits of alternative policy solutions.