07 Dec 2017
Australian defence spending rose sharply as a share of gross domestic spend (GDP) during the last century’s two world wars and to a lesser extent during the Korean and Vietnam wars. There were much smaller rises during the Iraq and Afghanistan conflicts. The recent low point was 2012-13, at about 1.6 per cent of GDP, in the aftermath of the global financial crisis.
The 2016 Defence White Paper, with its decades-long focus, proposed higher spending, and this was lifted again in the 2020 Defence Strategic Update released in early July. In launching the report, Australia’s Defence Minister, Linda Reynolds, noted spending on defence was part of the federal government’s efforts to help the economy recover from the COVID-19 crisis.
"The Government’s focus on encouraging onshore suppliers is a form of industry assistance not available to many other sectors.”
In the 2020 financial year, Defence funding is set to be $A42.2 billion. That’s just over 2 per cent of GDP and the budget will grow to around 3.5 per cent of GDP by 2029-30, according to ANZ Research’s calculations from the 2020 Defence Strategic Update. Defence’s significant role in the management of COVID-19 is supported from the Department’s funding envelope.
Australia’s total Defence spend as a share of GDP is in line with its GDP ranking, at 13th largest in the world. It is below countries such as Saudi Arabia (with a spend of around 8.8 per cent of GDP), Russia (3.9 per cent of GDP) and the US (3.2 per cent of GDP). Of the $US1.8 trillion per year spent on military equipment globally, Australia’s share is unsurprisingly small at 1.5 per cent, according to the Stockholm International Peace Research Institute (SIPRI).
Onshore expenditure
Most defence expenditure fits into three roughly evenly-valued categories:
There is also a small allocation to operations and operating expenses of around 4 per cent of total funding.
According to the Australian Strategic Policy Institute (ASPI), around two thirds of acquisition spending goes to overseas firms, while sustainment spending is almost the opposite with around 65 per cent local and 35 per cent overseas.
Given the acquisition and sustainment budgets are broadly similar, defence spending in the private sector is fairly evenly split between imports and domestic sources. At the moment therefore, the annual local spend is around $A13 billion.
The ratio between sustainment and acquisition spending will not remain constant, although higher levels of acquisition spending often beget higher sustainment and workforce spending.
The 2020 Defence Strategy Update outlines a plan to grow acquisition spending to 40 per cent of the Defence budget by 2029-30 (from a current 34 per cent) and sustainment expenditure to 32 per cent (from a current 30 per cent). Spending on workforce is expected to fall to 26 per cent (from a current 32 per cent).
For local suppliers, ANZ Research thinks the budget is likely to grow to around $A25 billion per year by 2029-30 (in nominal dollars) or around $A190 billion over the decade.
Below ANZ Research explains the Government’s ambition to boost the development of domestic suppliers, meaning this is a conservative estimate of the local spend by Defence.
Workforce increase
Although the workforce share of the budget will diminish over the coming decade, the number of staff will still rise. The Government plans to increase full-time Australian Defence Force (ADF) personnel by 800 and public servants working in the Department of Defence by 200, building on its 116,000 strong workforce. More detail on the plan is expected in 2021.
Major investments boost imports
Defence’s current pipeline of major investments is worth nearly $A270 billion for the coming decade, making it the largest in the department’s history.
The 2020 Defence Strategic Update includes plans for:
The acquisitions program, which is well under way, has resulted in a sharp increase in imports relative to exports in recent times.
As a SIPRI report points out, Australia’s arms imports increased by 37 per cent between 2009–13 and 2014–18, to the highest level since 1950.
“All armed services have received new major arms in 2014–18, but the main focus has been on aircraft and ships,” the report states. “Deliveries of F-35 combat aircraft and anti-submarine warfare aircraft from the USA made up 53 per cent of Australian arms imports in 2014–18, while ships from Spain accounted for 29 per cent.”
ANZ Research expects strong imports into the future in light of the planned investment program.
Greater onshore spend
While Defence depends on offshore specialist suppliers for its major acquisitions, it wants to develop the domestic defence industry base.
The April 2018 Defence Industrial Capability Plan and the Naval Shipbuilding Plan both had a clear intent to incentivise Australian suppliers to meet Defence requirements and this was reinforced in the 2020 Defence Strategic Update.
Launching the Update, Defence Minister Reynolds said “we are maintaining our policy of long-term certainty for Defence funding that was first put in place in the White Paper. Defence – and increasingly Australian defence industry – rely on funding stability, especially during this very challenging period for our economy”.
The Government has recently said it aimed to bring some of those who have lost jobs due to COVID-19 into the shipbuilding industry through training at the Naval Shipbuilding College.
Industry assistance
The Government’s focus on encouraging onshore suppliers is a form of industry assistance not available to many other sectors. For local suppliers it presents an advantage, although it is not without cost.
The Productivity Commission noted there is a “substantial ‘local cost premium’” which runs into billions on major defence projects, although it is difficult to quantify. The Commission also said the result is higher taxes (or lower government spending elsewhere), which diverts productive resources (including labour, capital and land) away from more efficient uses, detracting from Australian incomes.
Export challenges
Defence exports are small relative to imports. The government would like to change this. Building defence industry export capacity is part of the Government’s January 2018 Defence Export Strategy.
Budding exporters can sometimes be thwarted by scale. The workflow to defence is spasmodic and local producers often lack economies of scale. Only the minority of firms in the defence industry work exclusively for Defence, with most relying on other customers as well.
Many businesses need substantial working capital to position themselves for large international contracts, which is a risk as there is no guarantee of a contract win.
International work is often awarded on the basis of frontier advancements in technology. ASPI notes the future of defence is, in part, motivated by taking humans out of the “warspace” and it will enabled by the “fourth industrial revolution”, namely digital technology.
ASPI says the key elements of this include autonomous systems, artificial intelligence, more accessible space resources and 3D printing. This means contracts are difficult to win from anywhere other than the technology frontier.
Export Finance Australia is a Government organisation helping Australian companies take advantage of export opportunities by providing loans, guarantees, bonds and/or insurance. While there are examples of defence suppliers that have been able to access the assistance, the “Australian benefit” requirement has proven too high a hurdle for some.
At the moment, the defence industry is exporting around $A1.5–2.5 billion a year, with the annual figure lumpy. Most of the industry is not exporting. Those companies that do have limited markets. Of exports, 90 per cent are to the US, Indonesia and Oman, according to Tian.
Many of the Australian defence industry primes engaged in exporting, produce under licence to international parent companies. It follows that Australian companies are small players in international military trade. Globally, in 2008–18, Australia was the fourth largest arms importer but the 20th largest arms exporter.
As noted by Tian, that means the primes “generate limited technological or skills spill-overs that help the development of a domestic arms industry”.
Even with these challenges, the Update suggests there are plentifully opportunities worth investigating within the defence industry.
Cherelle Murphy is Senior Economist and Bansi Madhavani is Economist at ANZ
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
07 Dec 2017
18 Jun 2020