House of Commons - The Strategic Defence and Security Review and the National Security Strategy

The Strategic Defence and Security Review and the National Security Strategy - Defence Committee Contents

5 Ministry of Defence Budget

Comprehensive Spending Review 2010

191. The 2010 Comprehensive Spending Review (CSR) ran alongside the development of the SDSR. As part of the SDSR, the MoD undertook some 40 individual studies which were tailored to three scenarios—zero real growth and cuts of 10% and 20%.[191] The MoD's settlement was that defence spending in 2014-15 would be 1.8% higher in cash terms than in 2010-11, but 7.8% lower in real terms.[192] The total defence budget over the four years of the CSR was set at:

Data Source: HM Treasury, Spending Review 2010, Cm 7942

192. The CSR stated that "by focusing on maintaining key operational capabilities and by cutting out waste and inefficiency in the defence budget, the MoD will make at least £4.3 billion of non frontline savings over the Spending Review period".[193]

193. During our inquiry, Ministers commented that it was not possible to agree to funding levels outside the current CSR period and that this caused problems in planning for Future Force 2020, which to be achieved would require real terms funding increases from 2015 onwards (see paragraphs 174-190 above). Therefore planning in the MoD was being based on a flat rate level of funding from 2015. The MoD recognised that this created a difficulty in planning. In his report on Defence Acquisition, Bernard Gray, now the MoD's Chief of Defence Materiel, recommended that the MoD should move to a 10 year rolling budget which should be enshrined in law, in line with the French model, and it should encompass manpower, estates, equipment and support funding.[194] The previous Government did not accept this proposal but committed that the equipment programme would be planned to a longer time frame "with a ten year indicative planning horizon for equipment spending with the Treasury".[195]

194. Our predecessor Committee welcomed the commitment to a ten year planning timeframe for defence expenditure but doubted that the proposed ten year planning horizon would provide sufficient certainty to stabilise the equipment programme.[196]

195. During our earlier inquiry into the processes followed in the SDSR process, the Secretary of State for Defence commented that:[197]

Moving to a ten-year current spending horizon [...] makes a good deal more sense for defence. This is different from most departments; our acquisition programmes tend to be much longer lines and a ten-year budget would help us.

196. Bernard Gray, giving evidence to this inquiry in his new role as Chief of Defence Materiel, reaffirmed his view regarding ten year budgets for the MoD:[198]

Personally, my view is that Defence is significantly different from many other Departments, most of which exist with their cash flowing within a year or thereabouts. If they have capital programmes, they are relatively small compared with ours—notwithstanding Transport, which is still significantly smaller than the MoD for these purposes.

My personal view is that it would give greater stability to the planning of defence if we were able to give the long-term certainty that we are—kind of—discussing here. We could then say, "Okay, what is the financial planning horizon and how do we map against it?" That would allow us to plan, and indeed order, with greater certainty than the current Whitehall structure gives us. You must ask the Treasury for their opinion, but clearly they tend to be reluctant to have their hands tied in such matters.

He noted that the Treasury might respond:[199]

I suppose, to argue their case for them, they might say, "Well, economic conditions could be significantly different in 2015 and we should respond to those circumstances at the time. It might create unfortunate precedents, with everyone else arguing that we should be setting 10-year budgets." There are arguments on their side, but my personal view is that it would be an advantage and a useful discipline on all sides. But I am one individual.

197. We agree with our predecessor Committee that the scale and nature of MoD contracts is quantitatively and qualitatively different from other Government procurement and its assertion that greater financial stability could help to control and reduce the hundreds of millions of pounds of unproductive costs which are incurred annually to keep the equipment programme spend within each year's budget. We recommend that the MoD and the Treasury should establish mechanisms for a ten year budget for the MoD. It is vital that the MoD has greater certainty of resources as it plans to implement Future Force 2020 which is essential to the nation's security in an ever-changing world.

Over-commitment in the MoD Budget

198. The National Audit Office's Major Projects Report 2009, published in December 2009, made the following observations:[200]

The Defence programme is unaffordable

2.3 The Equipment Examination and subsequent Planning Round were successful in reducing the Defence budget's forecast overspend by £15 billion. The Department estimate, however, that the Defence budget remains over committed by £6 billion over the next ten years; this assumes an annual increase of 2.7 per cent in their budget after the end of the current Comprehensive Spending Review settlement in 2010-11. If the Defence budget remains flat in cash terms after this time, then the extent of the over commitment widens to £36 billion. In either case the budget remains consistently unaffordable over the next ten years.

2.4 Until there is a comprehensive review of defence policy, it will be difficult for the Department to think radically and rationalise the programme whilst limiting the impact on military capability. The Equipment Examination has also enabled the Department to shift some spending from future military requirements to support current.

199. In the SDSR, the Government stated:[201]

2.D.3 The legacy of over-commitment in the Defence programme amounted to around £38 billion. Some £20 billion of this is related to unaffordable plans for new equipment and support. Cancelling or changing major contracts to tackle this problem itself creates further liabilities. Negotiation with industry will reduce these as much as possible, but they will still make the short-term financial challenge greater.

2.D.4 In addition, there are systemic pressures in the two key blocks of Defence expenditure—equipment and personnel. [...]

2.D.5 This legacy of unaffordability, and these systemic pressures, mean that a major focus of work in the Strategic Defence and Security Review has been to eliminate over-commitment, to the greatest extent possible by reducing running costs to allow resources to be focussed on the front line. one of the stated main objectives of the SDSR was to bring defence policy, plans, commitments and resources back into balance and establish an affordable defence programme going forward.

200. We asked the MoD to set out how it had calculated its estimate of a £38 billion over- commitment in the defence programme and the effect of the SDSR in resolving it. In response, the MoD stated:[202]

The gap in the Defence Budget is the estimated difference between the cost of the Defence programme and the MoD budget under the assumption that the budget would rise in line with inflation over the ten years 2011-12 to 2020-21. The figures are based on a number of assumptions including changes in fuel prices, foreign exchange rates, and Armed Forces pay awards. It will, therefore, change over time. A figure of £38bn was calculated before the SDSR. The SDSR announced substantial reductions to the planned force structure. The measures announced go a long way to eliminating this excess but it will take time to work through the consequences of the SDSR decisions and bring the Defence Budget back into balance.

[...]

The SDSR established the policy framework for our Armed Forces and the capabilities that they will need to meet future challenges and achieve success on future operations while safeguarding Afghanistan. The spending review set out the resources allocated to Defence for the implementation of the SDSR. This will enable us to bring Defence policy, plans, commitments and resources into better balance through our annual planning process.

The outcomes of the SDSR and the Spending Review form the basis of the Department's annual Planning Round (PR11), which is still ongoing. The Planning Round looks out over 10 years. This process involves updating the estimated costs of the Department's current activities and adjusting for the estimated costs and savings arising from the changes announced in the SDSR. Until this process is complete it is not possible to reliably estimate the size of any residual shortfall. The Planning Round process routinely re-prioritises the Defence programme to ensure that the Department lives within its budget. PR11 is expected to conclude in spring 2011.

201. During our inquiry we explored the Government's assertion of a £38 billion gap in the defence budget and how this figure was arrived at and the degree to which it was based on actual commitments and how much was aspirational. Professor Malcolm Chalmers from RUSI stated:[203]

I think the key thing here is that it really does depend on the assumptions you are making [...] Even in a space of a few months, if the oil price goes up by $30 or $40 a barrel and everything else is left unchanged in your assumptions then you will probably have several billion pounds extra in your gap over the next 10 years. My plea would be that we need a lot more transparency on the assumptions being made in these numbers if we are to understand what they mean. The Government, when they came in last year, ordered a fresh look at our forward commitments and introduced what they felt to be more realistic assumptions in that forum. They came up with this £38 billion figure. It will be interesting to see what the figure is today, after a defence review, on the same assumptions.

Clearly, the assumptions will change, as we have more information, so my assessment—I have published this—is that if you take the same assumptions that underlay the £38 billion then we probably reduce that overhang over the next decade to something of the order of £15 billion. But, of course, some of those assumptions might change—service pay or equipment costs might rise less rapidly than we anticipated—so it does depend on that.

202. In March 2011, we explored this further with the Secretary of State for Defence.[204] In response, he promised us a note which would set out various pieces of information concerning the MoD budget over-commitment. We were disappointed with the response we received particularly as the Secretary of State had made a public commitment to provide the information.[205] We wrote again to the Secretary of State on 8 June requesting the following information on the MoD's budget:

A breakdown of expenditure approved at 'initial' and 'main' gate, including contract costs and running costs;
A breakdown of running costs such as Service Pay;
Details of the remaining budget gap; and
Details of the PR 11 settlement.

203. A response was received on 7 July which did provide some additional information but was still not as comprehensive as we would have expected.[206] As part of the response the MoD told us that the "gap was substantially in excess of £38 billion":[207]

However, this figure merely provides a snapshot based on the Department's understanding of the programme at a particular time. There are things that are now better understood, which had we known them at the time, would have affected the analysis of the position, and which indicate that in fact the genuine size of the gap was substantially in excess of £38 billion. For example, Bernard Gray's report in October 2009 had identified that a range of equipment programmes had not been accurately costed. Since coming into post as the Chief of Defence Materiel, and reviewing the equipment programme, Bernard has judged that a further £5.5 billion should be added to the overall cost of the equipment programme. In addition, the £38 billion figure did not take into account the fact that the MoD will now be meeting the full cost of paying for the successor deterrent, which is estimated at £8 billion over the next ten years, and for which at that time no part of Government had assumed they would pay.

204. We were disappointed by the MoD's response to our requests for a breakdown of the MoD's financial commitments, including details of the components of its estimate of a £38 billion gap in the defence programme and the size of any remaining budget gap after the SDSR. We note that the MoD now state the genuine size of the gap is substantially in excess of £38 billion. However, we also note the Secretary of State's assertion that the "for the first time in a generation, the MoD will have brought its plans and budget broadly into balance, allowing it to plan with confidence for the delivery of the future equipment programme". Without proper detailed figures neither statement can be verified. Given the difficulties the MoD has had in responding to our requests for a breakdown of the over-commitment in the MoD budget, we expect the Government in its response to this Report to set out in detail the basis for these statements.

205. We note the Secretary of State for Defence's commitment to carry out an assessment of the affordability of the equipment programme alongside an independent audit by the NAO. We are surprised that this assessment has not yet begun and expect to receive a timetable for this exercise in response to this Report.

MAJOR PROJECTS REVIEW BOARD

206. On 22 February 2011, during a speech on value for money in the MoD, the Secretary of State for Defence announced the establishment of a Major Projects Review Board. The Board would be chaired by the Defence Secretary and would receive quarterly updates on the MoD's major programmes to ensure that they are on time and within budget. This would begin with the 20 biggest projects by value and will expand to the 50 biggest projects. The Board met for the first time on 13 June 2011. Following the meeting, the MoD asserted that:[208]

Any project that the Board decided was failing would be publicly 'named and shamed'. This could include a project that is running over budget or behind expected timelines. This will allow the public and the market to judge how well the MoD and industry are doing in supporting the Armed Forces and offering taxpayers value for money."

207. We welcome the establishment of the Major Projects Review Board. The Board faces a major challenge and we will monitor its effectiveness in ensuring the MoD's programmes are on time and within budget. We recommend that the MoD consider the appointment of suitably experienced independent members to the Board.

Defence Reform

208. In parallel with the SDSR process, the Government also announced in summer 2010 that it would conduct a full organisational review of the Ministry of Defence. The Review had two strands: structural reform to reorganise the MoD into three pillars: Strategy and Policy, Armed Forces, and Procurement and Estates; and a "cultural shift" towards a leaner and less centralised organisation combined with devolved processes which carry greater accountability and transparency. The scope of the Defence Reform review was wide ranging and examined in detail all major areas of defence.

209. To oversee implementation, a Defence Reform Unit was established within the MoD to help plan and execute any structural/organisational changes. The Defence Reform Unit's report was published on 27 June 2011.[209] The Report made 53 wide-ranging recommendations. According to Lord Levene of Portsoken who chaired the review, the key recommendations were:

create a new and smaller Defence Board chaired by the Defence Secretary to strengthen top level decision making;
clarify the responsibilities of senior leaders, including the Permanent Secretary and the Chief of the Defence Staff, to strengthen individual accountability;
make the Head Office smaller and more strategic, to make high level balance of investment decisions, set strategic direction and a strong corporate framework, and hold to account;
focus the Service Chiefs on running their Service and empower them to perform their role effectively, with greater freedom to manage, as part of a much clearer framework of financial accountability and control;
strengthen financial and performance management throughout the Department to ensure that future plans are affordable and that everyone owns their share of responsibility for this;
create a 4 star-led Joint Forces Command, to strengthen the focus on joint enablers and on joint warfare development;
create single, coherent Defence Infrastructure and Defence Business Services organisations, to ensure enabling services are delivered efficiently, effectively and professionally;
manage and use senior military and civilian personnel more effectively, with people staying in post for longer, and more transparent and joint career management.

210. An implementation plan setting out how the Defence Reform Unit's review would be delivered is expected to be published in September 2011, with a view to overall implementation being completed by April 2015.[210]

211. We welcome the empowering of the single Service Chiefs, but are concerned that removing them from the Defence Board may result in an increase in the tensions between the three Services and encourage individual Service Chiefs to fight for their particular Service without consideration of overall defence requirements. It means that the Chief of Defence Staff will be the only Service representative on the Board, and could in turn leave them open to accusations of favouritism of their "home" Service over the others, whether justified or not. We intend to return to the command, control and accountability processes between the Chiefs of Staff in future inquiries. We will monitor the impact of this and the other reforms recommended by the DRU over the coming months as they are implemented. In addition we look forward to seeing in the near future greater detail from the MoD as to the budgetary implications of the changes being made.

212. We recognise the pace and quantity of change occurring within the MoD is considerable and understand how disconcerting this has been for the Armed Forces and MoD civil servants, particularly at a time when UK Armed Forces are conducting two major campaigns in Afghanistan and Libya. While we recognise that reform of the MoD is long overdue, change on this scale requires exceptionally careful management. In response to this Report we require that the MoD inform us of how it will ensure that reform is not derailed by the speed of its implementation. We note the recent publication of the Defence Reform Unit Report and will monitor the implementation of its recommendations. The MoD should provide updates on work to implement the recommendations in its Annual Report.

191 Defence Committee, First Report of Session 2010-11, The Strategic Defence and Security Review, HC 345, para 16, Q 11 and Q 16 Back

192 Adjusted using the OBR November 2010 forecast GDP deflator. House of Commons Library Research Paper 11/10, UK Defence and Security Policy: A New Approach, January 2011, p 28 Back

193 HM Treasury, Spending Review 2010, Cm 7942,October 2010, para 2.84 Back

194 Bernard Gray, Review of Acquisition for the Secretary of State for Defence, October 2009, p 10 Back

195 HC Deb, 15 October 2009, col 35WS Back

196 Defence Committee, Sixth Report of Session 2009-10, Defence Equipment 2010, HC 99, paras 84-86 Back

197 Defence Committee, First Report of Session 2010-11, The Strategic Defence and Security Review, HC 345, Q 62 Back

198 Q 548 Back

199 Q 550 Back

200 National Audit Office, Ministry of Defence: Major Projects Report 2009, December 2009, HC 85-I, paras 2.3-2.4 Back

201 HM Government, Securing Britain in an Age of Uncertainty: The Strategic Defence and Security Review, Cm 7948, paras 2.D.3-2.D.5 Back

202 Ev 126 Back