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SDR 02
Memorandum from DefenceSynergia
DEFENCE INDUSTRIAL STRATEGY – SOME THOUGHTS
Introduction
1. The UK is in the process of restoring its finances following a major recession that has burdened the economy with an excessive level of structural debt – circa £157bn has been quoted. In these circumstances the new Coalition Government has rightly accorded the tackling of this debt crisis top priority. However, the Government is also on record as having a preference for an export led recovery spearheaded by commercial and industrial growth.
2. This makes economic sense, especially as it will be essential to keep unemployment as low as possible in order to prevent benefit payments spiralling out of control and consuming tax receipts that could be better spent elsewhere stimulating growth. The knock on effects of a steady growth in GDP being an increase in overall tax revenues and stable interest rates at levels that do not add to the debt repayment burden.
3. One of the major contributors towards this aspiration for an export led growth strategy are the defence related industries. These 'high-tech' manufacturers supported by supply chain industries employ circa 300,000, mainly high skilled workers, exporting 22% of output – in 2006 this represented some £4.7bn out of a total turnover of £21.9bn. Putting the UK defence industrial complex 10th in a league table of 27 major exporting areas. (NB data from NAO/DASA/Oxford Economics)
4. Within the armed forces themselves there has been much soul searching as the needs of Iraq /Afghanistan have required excessive use of the Urgent Operational Requirement system. This in turn, coupled to the long running nature of these war operations, has led to a new paradigm where for the first time money to pay for ongoing operations is not coming from the strategic reserve but being placed as a burden upon the core defence vote without a compensating increase. Indeed, this may also be the case for the Trident replacement. When viewed from the perspective of the past decade of underfunding for defence as opposed to some very kind years for budgets such as education and health the situation between government departments is hardly comparable.
5. Indeed, the Chairman of ADS made the following comments at the end of his mainly supportive response to a recent speech by the S of S for Defence, he said this:
"Although defence should contribute to solving the current financial difficulties, Dr Fox would be justified in looking around the Cabinet table to challenge other departments to match the contribution to budget savings that defence has already made over the last two decades. Defence spending is half the percentage of Government spending and of GDP that it was twenty years ago. Other departments, where budgets have grown substantially over the same period, should be challenged in the same manner before more is asked of defence given that the demands on our Armed Forces exceed what was originally planned within the current budget."
MAIN DISCUSSION
6. It is taken as a given that the first priority of Government is defence of the realm and that the instrument through which this policy is primarily guaranteed is the armed forces. It is also accepted by all reasonable people that the size. structure and composition of these forces will always be constrained by the available finance. However, this restriction can, has and does remain flexible, most especially when the security and independence of the nation are directly threatened. Not least alone when threats are identified and quantified by reviews of both domestic and foreign policy – as now in the Strategic Defence and Security Review (SDSR).
7. The question is how, in financially straightened times, to pay for the personnel and equipment identified as priorities by the SDSR? Indeed, should they be funded at all? The answer from most defence lobbyists is a resounding yes to the second question but fraught with less certainty and confusion in respect of the first. The latter often being expressed by politicians, and increasingly by media and service pundits, in the form " we would like to bolster defence but just can't in the current financial climate". The 'dismal Jimmy' approach.
8. So it is incumbent upon everyone involved to examine all options most especially those that offer a positive and pragmatic solution based on mutual benefit to the country as a whole. One such solution offers a dual track by strengthening defence and at the same time providing the impetus to assist the economy to recover. Albeit anathema to HM Treasury - by increasing spending in support of defence budget projects thereby stimulating other commercial areas in the UK. The top 10 of these according to an 'Oxford Economics' report from 2009 are in order of size by total turnover:
Motor Vehicles employing 272000 workers, Construction employing 2,356000 workers,
Pharmaceuticals employing 129000 workers, Telecommunication employing 270000 workers, Banking and Finance employing 559000 workers, Manufacture of steel employing 106000 workers, Manufacture of electrical components employing 50000 workers, Manufacture of machine tools employing 30000 workers, Manufacture of apparel employing 53000 workers and Defence directly employing 160000 workers (another 145000 in related defence supply chain activity).
9. In 2006 only Pharmaceuticals on the list above invested more in R&D than the defence industries (£7.42bn versus £2.39bn) and only Motor Vehicles, Banking, Pharmaceuticals and Steel exports exceeded those of the defence industries (£22.10bn, £18.38bn, £14.59bn, £12.64bn and £4.70 respectively). In fact when 'Oxford Economics' collated the available data in respect of all UK's major commercial and industrial areas they concluded that defence ranked 3rd out of 27 in the UK behind publishing and machine tool manufacture. This is what they said:
"The outcome...is that the strongest economic case (excluding capacity considerations) for increasing Government investment in order to stimulate the economy can be made for the publishing, machine tools and defence sectors, as these sectors have the three lowest average rankings. However, once capacity is taken into account, the case for supporting the defence sector is strengthened, as it has greater spare capacity than the other sectors.
This study has examined a wide range of benefits which can accrue from an increase in Government investment within a sector. While immediate impacts are necessary to help the economy exit recession, any investment must also take into account its possible longer term impacts, through its support of R&D and export intensive industries. To be effective an investment needs to be aimed at industries that can absorb an increase in demand; if an industry is running at full capacity the increased investment will merely add to future orders, and any immediate benefits from investment will be lost. As a result investments need to be targeted in such a way that their positive impact is balanced between short term and long-run benefits, and a sector has the capacity to ensure that its benefits are felt immediately and are not delayed until capacity becomes available".
10. This reference to 'Capacity' is perhaps the crux of the issue as an industrial led economic recovery will depend upon both short and long term returns for any Government investment. In the case of the UK's defence industrial complex it has been acknowledged that spare capacity already exists – according to the CBI and EUROSTAT surveys on industrial trends the defence industry in the UK is currently running below capacity. The later being influenced by the irregular nature of demand in the defence sector accustoming it to increasing production rapidly in order to meet client procurement targets. This assessment was confirmed in the 'Oxford Economics' study which indicated that of the eleven sectors for which capacity data were available, the defence sector ranked 3rd in the UK for spare capacity to allow for rapid expansion.
11. It is this investment leading to rapid expansion that is the key to producing short term but sustainable growth in the economy, not least by increasing 'high-tech' employment opportunities for directly and indirectly employed labour. For every job created in the defence industry, 'Oxford Economics' estimate that 1.6 jobs are created elsewhere in the economy. Therefore, a notional
£100 million investment in the defence industry will create 1,885 jobs throughout the UK economy, 726 of which will be in the defence industry itself. This could equate to 18,850 new jobs for every £1bn invested before other theoretical economic multipliers are applied in respect of reductions in unemployment payments, local economy boosts from wages earned and the extra tax revenues accrued from incomes, corporate taxation and boosted exports.
12. 'Oxford Economics' do not say what the negative effects on the economy and defence industries might be if the decision of the Treasury were to reduce MOD's ability to invest in and sustain its current level of contract activity. One can speculate that the loss of confidence will lead to redundancies, a fall in exports, a reduction in R&D expenditure and the inexorable decline of this area of manufacturing and innovation. The long term affect being to emasculate one of the UK's most successful wealth generating areas of expertise. As the economy recovers more slowly – and recover it will – the British armed forces may have to look evermore to overseas companies for the hardware it requires with the knock on consequences to the balance of payments and employment prospects at home. Once the capacity, infrastructure and expertise to build ships, aircraft and sophisticated weapons platforms is lost it will be difficult to regain – probably financially impossible.
CONCLUSION
13. The UK is experiencing a financial debt crisis and is slowly emerging from recession. The Coalition Government has rightly set its first priority to reduce the debt burden but at the same time has indicated that it wishes private industry and commerce to lead the way to recovery through increased domestic and export growth. Nevertheless, the Treasury has taken the view that major cuts in public expenditure are still necessary as current forecast rates of growth are insufficient in themselves to alleviate the debt burden within a reasonable time-frame.
14. To this end all departments of state (excepting overseas aid and the NHS) are being tasked to save between 20 – 40% of their departmental budgets. A huge ask. Within this stricture the MOD has been tasked to find 20% savings from financial year 2011/12 despite having been starved of funds over a decade or more.
15. However, with an SDSR due to report in the Autumn and its results uncertain other than they should be foreign policy and threat led, there is a case for exempting the defence budget from any cuts until after the review. To do otherwise is to 'situate the appreciation' and chance the UK's security and manufacturing base for purely fiscal reasons. That the MOD must put its own house in order and operate in the most cost effective way possible is not disputed, nor is the possibility that the UK armed forces may have to be restructured to meet the requirements identified by SDSR. Only the motivation of those responsible for financing our armed forces and the logic employed is in doubt.
16. But there is a way forward being suggested by those most closely associated with the economics of the defence industrial complex. They offer a methodology that links the future of the British armed forces inextricably with the defence industries (and vice versa) and one that directly supports the wider UK economic recovery. The thesis suggests that there is no need to cut the British armed forces further than the identified threats indicate they should be sized, structured and equipped and that Government investment in the various defence and support industries will pave the way for economic recovery whilst at the same time providing for robust and appropriate security of the United Kingdom.
18. For HM Treasury, who have responsibility to ensure sound public finances, there is another clear imperative – 'the first duty of any Government is defence of the realm and its people'. But, although it is the Government that leads in this process it is the people who populate the defence industries and armed forces to whom politicians must ultimately answer. In this latter respect it is the duty of Government to ensure that the armed forces and their supporting industries are viable and credible and therefore capable enough to deter an aggressor.
Deterrence always costs far less in lives and treasure than war.
16 August 2010
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