House of Commons - Managing the defence budget and estate

Managing the defence budget and estate - Public Accounts Committee Contents

1 Managing the defence budget

1. The Department needs effective financial management to direct and control the £42 billion of resources for which it is responsible and to ensure successful delivery of its aims and objectives within budget.[2] Without good financial management, the Department has struggled to deliver an affordable plan and live within its means.

2. Consequently, the Department has found itself facing a budgetary black hole of up to £36 billion over the next ten years.[3] This has resulted in short-term decisions which have delivered poor value for money. For example, in 2008 contractual commitments were made to procure new aircraft carriers without identifying compensating savings across the whole programme. Because these savings were not identified, within a year it was necessary to delay the project, resulting in an enormous cost increase.[4]

3. Although the size of the budget shortfall is highly susceptible to assumptions regarding future Spending Review settlements, further cuts in funding without associated cuts to outputs will cause the deficit to increase.[5] The recent Strategic Defence and Security Review highlights the importance of bringing the budget back into balance.[6]

4. To ensure that its spending plans are both sustainable and affordable, the Department must set out a financial strategy.[7] The financial strategy should articulate and review, on an annual basis, the spending priorities across the Department.[8] The lack of such prioritisation to date has meant that every time savings need to be made, the entire organisation has to be reviewed to determine where cuts would have the least impact on capability.[9] The result has been short-term decisions to delay, de-scope, and reduce equipment numbers after contracts have been signed with industry.[10] Such decisions are extremely poor value for money.[11] A defence programme which has been mapped to strategic priorities would mean that there is a clear basis for determining where savings should take place when funding falls short.

5. The financial strategy should contain within it an unallocated reserve of funds to allow the Department to respond to unexpected events.[12] For example, the Department's decision to reprioritise £300 million per annum to Afghanistan meant that tough decisions had to be made to close air bases and reduce training, as there was not enough flexibility in the budget to enable this to happen otherwise.[13]

6. Budget flexibility would also help to deal with the effects of optimism bias and poor risk management.[14] The Department has a tendency to be over-optimistic about the cost and likely delivery dates of major projects.[15] In such instances, setting aside an unallocated contingency would mean that cost increases on major projects would not lead to cuts being made elsewhere, as has previously been the case.[16] Similarly, the Department does not have a good track record in identifying and budgeting for financial risks.[17] An unallocated reserve would enable the effects of risk to be managed without removing funding from other areas.

7. The financial strategy should be regularly updated with an annual review of the assumptions which underpin it.[18] This would help ensure that decisions based on the strategy are relevant to current defence needs and the financial position of the Department - rather than being hamstrung by the absence of a strategic defence review, as has been the case over the past twelve years.

8. The recently published Strategic Defence and Security Review provides the Department with an opportunity to "reset" its budgets in line with expectations of likely funding.[19] However, the greater challenge will be for the Department to maintain that balance in the long term, between strategic reviews.[20] The development of a financial strategy would put the Department in a better position to balance expected funding and significant changes to capability.[21]

9. The Accounting Officer's responsibilities, as set out in Managing Public Money, include taking personal responsibility for value for money.[22] If value for money is placed at risk, then the Accounting Officer should seek a ministerial direction where Ministers decide to continue with a specific course of action that the Accounting Officer has advised against.[23]

10. There should be no doubt that ministerial directions should be sought when projects which would make the overall programme unaffordable are approved without corresponding cuts being identified elsewhere in the defence budget.[24] They should also be required when decisions are taken to delay or otherwise alter existing projects in a way which would jeopardise value for money for the taxpayer.[25] The Department's Accounting Officer told us that, in the case of the aircraft carriers, he did not seek a direction because in his view there were no issues of regularity or propriety and the concerns about affordability in themselves did not warrant a formal direction.[26]

11. Under present arrangements in the Department, the Finance Director leads the search for in-year savings but is not responsible for the long term management of the defence budget.[27] This contradicts the guidance laid out for Departments in Managing Public Money, which explicitly states that the Finance Director should:

Maintain a long term financial strategy to underpin the organisation's financial viability within the agreed framework; and
Develop and maintain an effective resource allocation model to optimise outputs.[28]

12. Currently, it is the Director General for Strategy who manages the long term plans for the Department.[29] The Finance Director's role in long term planning has been limited to providing advice on the financial aspects of plans.[30] This has eroded the authority of the Finance Director and contributed to a pattern of over commitment in future spending plans.[31] Mrs Brennan told us she would make sure the Department complies with the requirements in Managing Public Money that relate to the Finance Director's role.[32] We welcome this commitment to ensuring that the Finance Director has primary responsibility for strategic financial planning in the Department.