Pressures on Defence Policy: The Defence Budget Crisis

Research Paper 20 1999-2000

Derek Woolner
Foreign Affairs, Defence and Trade Group
11 April 2000

Contents

Major Issues
Introduction
The Origins of the Current Defence Budget

The Objectives of Defence Financial Management Policy

A Consequence of Failure: Over-commitment to Capital Programs
Where to Now? The Continuing Sources of Stress in Defence Funding

Prospects for the Defence Budget
Conclusion
Endnotes

Acronyms

ADF	Australian Defence Force
AEW&C	Airborne Early Warning and Control aircraft
Australian Defence	Australian Defence (the 1976 White Paper)
C-130H	C-130H Hercules transport aircraft of the RAAF
CSP	Commercial Support Program
DA94	Defending Australia 1994 (the 1994 White Paper)
Defence	Department of Defence
DER	Defence Efficiency Review (of 1997)
DoA87	Defence of Australia 1987 (the 1987 White Paper)
DoFA	Department of Finance and Administration
DRP	Defence Reform Program
F18	F/A18 Hornet, fighter/attack aircraft of the RAAF
FFG	FFG-7 Class of frigate operated by the RAN
FSR	Force Structure Review (of 1991)
INTERFET	International Force East Timor
JSCFADT	Joint Standing Committee on Foreign Affairs, Defence and Trade (of the Federal Parliament)
NPOC	Net Personnel and Operating Costs (of running military equipment)
P3C	P3C Orion long range maritime patrol aircraft of the RAAF
RAAF	Royal Australian Air Force
RAN	Royal Australian Navy
RMA	Revolution in Military Affairs (applications of high technology warfare)
UNTAET	United Nations Transitional Administration in East Timor

Major Issues

The Government is about to release a Green Paper on defence, initiating a process of public debate leading up to the publication of a White Paper in late 2000. The timing is fortuitous. A range of pressures are working within the Defence budget that, if unattended, could produce a crisis in defence policy in five or six year's time.

If no significant policy adjustments are made in the meantime, it will have become apparent by then that the Australian Defence Force (ADF) can no longer perform all the roles it does currently within a budget of the same size. The need to divert funds from the allocation for major new military equipment to pay for wage increases and for increased operational readiness will have, by then, almost ended the ability of the Department of Defence (Defence) to buy these items. It also will have become apparent by then that even the capacity to operate with existing inventories is being squeezed to the extent that operational expenditures effectively will be halved by 2020.

The deployment of elements of the ADF to East Timor in 1999 may prove to be the significant event that exposed the dimensions of this problem. It highlighted the extent of the cost to simply deploy personnel to an operational area and maintain them there in a state sufficient to apply military force, even where the full application of this force is not eventually required.

The Timor deployment also highlighted a difficult tension at the heart of defence policy. This is the desire that the Australian Defence Force (ADF) be two not always compatible things within a limited budget. Firstly, a technological organisation focused on being the most advanced in the region. Secondly, and at the same time, a force with sufficient personnel to intervene at locations within Australia's region to keep, for instance, the peace on the ground.

In determining the future shape (generally referred to as force structure) of the ADF over the past 25 years, the former objective has been the focus of attention. The expectation was that when a peacekeeping contribution was sought Australia might or might not take part but would decide on the basis of what ADF units it was best place to offer for the task.

The Timor experience indicates that this approach can be risky. Over the last quarter of a century it has been Defence's de facto financial management policy to restrict expenditure on personnel and other defence running costs and thus maximise funding for equipment programs. The risk taken was that the relevant elements of the ADF might not be ready to deploy when needed.

In the months leading up to the Timor deployment this policy was reversed. The Army's 1st Division in Darwin was prepared for deployment at short notice and, as the implications of sustained operations on Timor became more apparent, large elements of the financial management policy were abandoned. The Government agreed to an additional 3500 Service personnel, costing around $240 million per annum at current average ADF salary costs.

Part of the debate leading up to the white paper is likely to be on the extent to which this switch from technology to personnel should be continued. One of the main issues that will have to be considered is that, despite what appeared to be popular assumptions before deploying the Timor force, additional defence personnel are not cheap.

Since the mid-1970s until the current revisions, the argument that our strategic advantage lay with technology has held sway. Yet even then there has been insufficient finance at significant times to allow Defence to fund force structure objectives resulting, amongst other things, in there being insufficient Regular Army battalions to sustain the commitment on Timor.

Since the mid-1970s Defence planners have attempted to avoid such problems by trying to reduce the proportion of the defence budget allocated to personnel costs. For the last decade this approach has focused government attention on efficiency programs centred on personnel reductions and outsourcing of functions. The latest of these, the Defence Efficiency Review (DER) of 1997 was to result in recurrent savings at maturity of about $770 million to be used to improve ADF military capabilities. The projections assumed that the ADF could be reduced to a force of 42 500. This was soon abandoned and numbers held at 50 000.

Consequently, $632 million of the DER savings will now be spent on personnel with the cost of the additional 3500 personnel bringing total extra labour costs to $900 million. This will more than absorb all the predicted recurrent savings from the DER.

Additional personnel costs will more than absorb all the predicted recurrent savings from the DER.

A significant number of personnel will have moved from essentially commercial activities to combat related duties but they will find that few new technologies for their employment will be funded from management efficiencies.

The failure of the efficiency programs of the 1990s to divert more funds to equipment procurement has contributed to a current crisis of defence funding with significant implications. Throughout the 1990s, Defence has been contracting new equipment without sufficiently increasing the relevant appropriations. Consequently, Defence now has an order book of major equipment project contracts on which $20 billion remains to be paid. In addition, new programs worth around $5 billion were approved in the 1999-2000 Budget. Compared to $2275 million allocated to capital equipment in the current budget, this obligation represents more than ten years expenditure-some indication of why Dr Allan Hawke, Secretary of the Department, has described its financial position as 'parlôus'.

However, the problems for the budget extend beyond the immediate equipment program. Defence does not have ten years in which to absorb the current over programming. By around 2007 the ADF will have to respond to the problem of block obsolescence, an occurrence when many of its most important equipments will begin to retire at around the same time. Dr Hawke has quoted estimates of the cost of replacing this equipment at between $88 and $106 billion in the period from 2007 to 2020. Allowing for existing commitments, this is a notional bill of up to around $131 billion over the next 20 years. Furthermore, it is likely that the ADF will desire, or be instructed, to develop new capabilities over the next two decades.

Paying for such a program would cost more than two and a half times the current annual allocation to major capital equipment. Undoubtedly, options will be developed to ameliorate the total cost of the capital equipment program and to stretch its duration. It is clear, nonetheless, that these cost so exceed current funding that it will not be possible to replace some types of defence capabilities when they are retired.

It will not be possible to replace some types of defence capabilities when they are retired.

What makes this coming period significant in defence planning terms is not simply the potential costs involved in block obsolescence but that the equipment involved supports many of the central capabilities of the ADF. Failure to suitably replace such equipment during this period will mean, in most cases, a loss of defence capability. That is, there will be some military roles which the ADF will cease to be able to perform.

There will be some military roles which the ADF will cease to be able to perform.

Yet it will not be possible to fund the desired programs within the Defence budget if kept at its current size. Defence labour costs continue to rise. Consequently, throughout the 1990s, defence has been obliged to find the difference from other areas of the budget. This happened again in February 2000, when $380 million of the proposed 1999-2000 equipment budget had to be diverted to meet defence labour and other costs. Indications are that the personnel component of the Defence budget will continue to increase over the longer term.

Were such a tendency to continue over the next 20 years Defence would have to find some $3.9 billion dollars per annum by 2020 from other areas of the budget. This would be from a Defence budget of little more than $13.3 billion, of which $10.2 billion would be consumed by personnel costs.

There would be little finance left for any other military activities. For sake of illustration, if all the cost pressures present in the current budgetary structure were allowed to develop without correction, but assuming no significant attempt to increase the Defence budget from today's levels, funding of major capital equipment would be stopped in about 2009. By 2020 the same process would have reduced expenditures on other operational costs by about half.

On the other hand, with the same assumptions by 2020 the annual Defence budget would probably be around $26 billion at current nominal values. This is almost double the amount that would be available if the current budget continues to be implemented with only minor increases in value. It is also an amount that so exceeds any projection of likely defence budgetary increases that it could not be achieved without considerable changes to the nature of the Commonwealth budget and/or to current fiscal policy.

The ADF has lost significant military capabilities in the past more because of financial pressures than as the result of cogent debate. The coming Defence budget crisis threatens to remove more. With its current budget, Defence cannot overcome the developing pressures of equipment, personnel and operating costs to allow the ADF to continue as it has for the last quarter of a century.

The implication of the developing financial circumstances is that the forthcoming public debate will have to consider a fundamental re-evaluation of the role of military forces in national security. The debate will probably consider a range of options, from greatly increased defence spending to a much reduced role for the ADF. The best answers may lie somewhere in between but the situation of the Defence budget indicates that defence policy can not for long reconcile the current roles of the ADF at the current level of defence expenditure.

Introduction

This paper discusses the current and likely future state of defence finance as one of the major forces shaping strategic policy over the next 20 years. The deployment of elements of the Australian Defence Force (ADF) to East Timor during 1999 brought into relief the consequences of an approach to defence finance which has, for the last quarter of a century, sought to restrict expenditure on personnel and on operating costs in order to have sufficient funds for capital investment, mostly for new equipment. Preparing the ADF for deployment required diversion of funding and deploying and sustaining it on Timor has required the striking of a special increment on the Medicare Levy.

These additional costs have occurred at a time when a declining budget surplus has again foreshadowed a restricted Commonwealth Budget. The resultant competition for government funding has focused debate more clearly on the policy conflict between a defence capability designed to promote Australian security by intercession in regional conflicts and one to do so by development of technological capabilities superior to those of other relevant regional nations.

Issues such as these will be posed for national debate in the process of developing the Government's next white paper on defence policy, due later this year. In reality, however, changes to the ADF's capabilities over the last quarter century have owed as much to poorly foreseen financial pressures as they have to any premeditated decision making. It is the contention of this paper that the pressures on defence funding over the next 20 years will be such as to force radical policy changes, as defence policy on its current settings is not be affordable for more than a few years.

This paper does not examine the policy options which might emerge over the next decade or so. Rather it focuses on the nature and consequences of the defence funding situation. It explains the development of the current financial circumstances and identifies the nature of significant problems facing the financing of current policies covering personnel, operational costs and capital equipment. The paper then extrapolates some of the major trends in expenditure in these areas to highlight the dilemmas which would face any government attempting to maintain current policy through the next 20 years. Whilst these projections are illustrative rather than predictive, they do demonstrate funding problems so large as to make changes in policy inevitable.

The Origins of the Current Defence Budget

Discussion about the current state of the Defence budget is coloured and influenced by a number of complex factors:

• levels of real expenditure on Australian defence have been falling since the late 1980s
• efforts to maintain the 'purchasing power' of the Defence budget have centred on management approaches which are themselves contentious
• the current ADF deployment in East Timor will a have significant short-term impact on the Defence budget
• the ADF was insufficiently prepared for a deployment to Timor of extended duration,⁽¹⁾ indicating that a change in longer term spending priorities within the Defence budget may be needed and that this could persist beyond the Timor deployment
• a number of expensive military systems reach the end of their economic life from about 2007 up to around 2020 and their replacement will demand considerable expenditure, and
• new military technologies, such as those encompassed by the so-called Revolution in Military Affairs (RMA) are emerging and are themselves expensive.

The nub of the financial problem facing the Department of Defence [hereinafter, Defence] is that, to date, it has proved impossible to fund the force development plans created to meet the policy of 'defence self reliance'. This policy must now be approaching traditional status-it has been maintained by governments since the early 1970s and first was coherently enunciated in the 1976 White Paper, Australian Defence. The 1987 Defence paper, Defence of Australia, (DoA87) developed a logical frame work of priorities to make the self reliance objectives manageable. Despite this, it has proved impossible over more than two decades, for Defence to fund the force development plans that have been created to meet the 'defence self reliance' approach to planning ADF capabilities.

The nub of the financial problem facing the Department of Defence is that, to date, it has proved impossible to fund the force development plans created to meet the policy of 'defence self reliance'.

Many of the factors which have perpetuated this situation persist and will continue to be an influence on the development of future ADF capability. Therefore, to assess the prospect of sustaining current policies, it is necessary to discuss the origins of the current situation and the likely ongoing effects of its major determinants.

Restricted Funding and 'Management' Improvements

Approaches under the Hawke and Keating Governments

In promoting DoA87, the (then) Defence Minister, Kim Beazley, argued that the traditional basis of the politics of defence was, henceforth, dead. This had been the cry that government should spend more on defence in response to any perceived shortcoming. Hence, the Party which promised to spend more on defence claimed the better policy. Beazley argued that DoA87 gave defence policy a logical structure around the concept of Defence self-reliance which would transform the argument from one of how much was being appropriated into that of how well defence funds were being managed to achieve objectives.⁽²⁾

His view was to prove correct politically, in that the major parties did not thereafter contest defence policies on the basis of which would spend the most. However, the view proved to be incomplete. Although Minister Beazley hinted that the defence self-reliance objectives outlined in DoA87 could now be obtained without substantial increases in expenditure, the document nonetheless foreshadowed Defence being funded at a rate 'generally within the order of 2.6 per cent to 3.0 per cent of GDP'.⁽³⁾

As events unfolded, however, the Defence budget had to contribute to the tightening of Commonwealth fiscal policy in the aftermath of (then) Treasurer Keating's warning that Australia's balance of payments placed it at risk of becoming a 'banana republic'. Hence, in the financial year immediately following the release of DoA87, the proportion of GDP allocated to defence was reduced from the 2.5-2.6 per cent which had prevailed since the beginning of the decade, to 2.3 per cent and has thereafter declined further.

Only four years after DoA87, the Force Structure Review 1991 (FSR) reported that there had been no real growth, on average, in the Defence budget since the release of DoA87 and concluded that, were funding to continue at this level over the next decade, only three-quarters of its programs could be implemented. If, instead, defence funding was cut by an average of one per cent, only half of the plans could be implemented.⁽⁴⁾ The response embodied in the FSR was to implement a series of management efficiencies, staff reductions and the outsourcing of some functions, to allow Defence to broadly achieve its planning objectives with no real increase in funding.⁽⁵⁾

In the event, by the end of the 1990s defence outlay had declined by 2.3 per cent compared with 1988-89, a loss which by 1997 was equivalent to some $230 million per annum.⁽⁶⁾ However, in 1994, the White Paper Defending Australia (DA94) stated that continuing management efficiencies could support the development of military capabilities, but only until the last few years of the decade. After that, and throughout the first decade of the 21st Century, real growth in defence funding, sufficient to hold Defence Outlay at a level of about 2 per cent of GDP, would be required.⁽⁷⁾

The demand for additional funds would be driven initially by conflict between the costs of new equipment programs and improvements in personnel remuneration with the latter expected to absorb most of the gains of management efficiencies.

From around 2007 the retirement of large sections of the ADF's most expensive types of equipment at about the same time (a circumstance referred to as 'block obsolescence') would begin to drive defence costs.

Actions of the Howard Governments

When the Coalition came to power in 1996, it promised to retain defence spending at the levels planned by Labor. This was for a real reduction of 0.5 per cent in 1996-97, with the level of real funding then held constant until the turn of the century. The Defence Minister, Ian McLachlan, emphasised early in his term that there would be no possibility of any increase in defence spending during the forthcoming three years.⁽⁸⁾

Instead, the Government has sought to accelerate the management processes begun in the FSR of 1991. There was an early implementation of an election policy to transfer $125 million per annum from administration to the development of ADF capabilities.

The Minister proceeded thence to a full scale overhaul of defence management with the Defence Efficiency Review (DER) saying that:

The DER, released in March 1997, proposed many changes in the organisation and work of ADF and Defence Department staff, most of which were adopted for implementation as the Defence Reform Program (DRP). The objective of the DRP is (as was the case with the FSR) to improve the efficiency of Defence management so that funds and personnel can be diverted to improve capabilities in the ADF's combat forces.

The DER identified one-off savings expected to reach $500 million over several years (mostly through the sale of Defence properties), but occurring at an annual rate of only about $55-$60 million.⁽¹⁰⁾ Recurrent savings were estimated to release at least $770 per annum and, perhaps, levels approaching $1 billion, then equivalent to about 10 per cent of Defence outlay.⁽¹¹⁾ These were in addition to the ongoing efficiency savings of the FSR process.⁽¹²⁾ By June 1996 the FSR had generated recurrent annual savings of $450 million,⁽¹³⁾ and these were estimated to reach $530 million per annum by 1999-2000.⁽¹⁴⁾

The DRP efficiency initiatives concentrate on personnel and operating costs. Almost 35 per cent of the DRP first phase recurrent savings were to come from personnel downsizing alone. Approximately 18 per cent more eventually was to become available from reduced operating costs, many in the Defence estate,⁽¹⁵⁾ as rationalisation of defence facilities led to reductions in the costs of property upkeep. These two areas provided something over half of the DRP savings.

Mass Reductions of Defence Personnel

The salient characteristic of these 'managerialist' approaches to Defence has been mass reduction of personnel numbers. Under the FSR process:

• 16 210 ADF and civilian positions were removed between June 1991 and June 1996.⁽¹⁶⁾
• The DER estimated that its recommendations would lead to the reduction of a further 7800 ADF and civilian positions.

The DER proposed the market testing of additional activities, involving some 7000 military and 5900 civilian positions, under the Commercial Support Program [CSP-i.e., outsourcing] to transfer appropriate functions to commercial organisations. However, of the staff reductions 'at least' 2000 Service personnel were to be relocated to positions in the combat force.⁽¹⁷⁾ Thus the reduction in numbers recommended by the DER was meant to accomplish:

• a refocussing of ADF activities on combat and essential technical support areas, with
• reductions of uniformed members employed in non-combat related support areas such as administration.

The principle effect of this history of managerialist efficiencies and cost cutting is that the ADF has become a comparatively small force. Before the East Timor deployment, the ADF was programmed to be reduced to about 50 000 personnel by the end of 1999-2000. In June 1981 there were 72 520 in the ADF.

Significant reductions in Defence staffing are not just a product of 1990s style managerialist approaches, however. In the previous six year period, between June 1984 and June 1990, Defence personnel numbers fell by over 17 900, most of them (some 14 600) being civilians.⁽¹⁸⁾ These initial personnel reductions in the 1980s were due mostly to

changes of structure, as dockyards, munitions factories and other Defence production facilities were privatised or corporatised and recording of their staff costs was removed from the Defence budget.

Table 1: Permanent ADF and Defence Civilian Employment

	Permanent ADF		Defence Civilians
As at30-Jun	Total	% Total	Total	% Total	Total
1976	68774	68.3	31847	31.7	100621
1977	70081	69.0	31551	31.0	101632
1978	69870	69.0	31377	31.0	101247
1979	70198	69.6	30613	30.4	100811
1980	71531	70.1	30488	29.9	102019
1981	72518	70.5	30336	29.5	102854
1982	73185	78.2	20374	21.8	93559
1983	72782	74.7	24704	25.3	97486
1984	71642	74.4	24596	25.6	96238
1985	71382	63.9	40345	36.1	111727
1986	70049	63.7	39937	36.3	109986
1987	70761	65.1	38010	34.9	108771
1988	70582	67.6	33895	32.4	104477
1989	69629	74.1	24299	25.9	93928
1990	67841	73.8	24108	26.2	91949
1991	69158	73.4	25006	26.6	94164
1992	67054	73.8	23832	26.2	90886
1993	62440	73.9	22105	26.1	84545
1994	58932	73.8	20966	26.2	79898
1995	58188	73.7	20767	26.3	78955
1996	57580	73.9	20372	26.1	77952
1997	57216	75.0	19115	25.0	76331
1998	55174	75.5	17943	24.5	73117
1999	52895	76.1	16570	23.9	69465

Source: Alan Shepard, Trends in Australian Defence: A Resources Survey, Australian Defence Studies Centre, 1999, Table 5, p.46, for 1976 to 1998.

Defence Annual Report 1998-99, Table 8, p.21, for 1999.

The principle effect of this history of managerialist efficiencies and cost cutting is that the ADF has become a comparatively small force. Before the East Timor deployment, the ADF was programmed to be reduced to about 50 000 personnel by the end of 1999-2000. In June 1981 there were 72 520 in the ADF.

This objective would have represented a situation where, between 1985 (when defence still operated a network of defence production facilities) and the end of this financial year, Defence would have shed more than 45 000 full time positions.⁽¹⁹⁾

The Objectives of Defence Financial Management Policy

The 1976 white paper, Australian Defence first enunciated a specific policy to reduce recurrent expenditure-personnel, some operational and administrative costs-in order to boost investment⁽²⁰⁾ (then seen as mostly comprised of new major equipment). With short lived variations, this has since been de facto Defence financial policy.

The need to prioritise resource allocation reflects what has been a continuing need to allocate funding for forthcoming equipment programs, which frequently has been seen as a 'looming' problem and has been the central objective of defence planning since the publication of Australian Defence.⁽²¹⁾

Priority for Defence Equipment Procurement

None of the plans of the quarter of a century since Australian Defence have made the objective any easier to obtain or ended the need for this resource allocation policy to continue.

Nevertheless, throughout the period since the mid-1970s, it has proved possible to systematically up-date the equipment inventories of the ADF and keep them at a level of technological capacity which has not been challenged by any nation in Australia's region.

This achievement has been despite (although in a broader budgetary sense, because of), the loss of some ADF capabilities, service life extension of some equipment types or delay in the acquisition of some new types of capability. For example:

• The aircraft carrier Melbourne was retired, together with its Fleet Air Arm fixed wing aircraft, without replacement principally because of financial limitations
• Army Regular battalions were reduced from six to four, with some capacity diverted to the Ready Reserve scheme which was itself abolished on 'value for money' grounds in 1996
• The RAN's air warfare destroyers currently are being retired with no commitment to a replacement capability
• The Army's M113 Armoured Personnel Carriers [APC], purchased during the Vietnam War, continue in use after many rebuilding programs with no replacement program yet scheduled
• the RAAF has been arguing since the delivery of the F/A-18 in the early 1980s for a capability such as the $2.7 billion Airborne Early Warning and Control [AEW&C] aircraft, which will not now enter service until the mid-2000s.

Limitations on Readiness

Significantly more impact has been felt on those areas of expenditure specifically marked for restrained spending. ADF capability consists as much of the Force's capacity to conduct military operations as it does the sophistication of its equipment. In Service dogma, force structure (equipment and formations) and preparedness comprise force capability. Preparedness describes the capacity of the structure's ability to conduct operations and consists of two components,

• readiness (ability of a force element to perform a designated role) and
• sustainability (ability to support a force element until a task is completed).⁽²²⁾

The consequence of the priorities of financial policy since the mid-1970s has been to make preparedness an issue of recurring controversy and an area of inadequate progress in policy development. DER supporting papers conceded that Defence lacked a basis for deriving preparedness objectives,⁽²³⁾ and that preparedness is one of several related issues currently overlooked in the force development process.

DER supporting papers conceded that Defence lacked a basis for deriving preparedness objectives, and that preparedness is one of several related issues currently overlooked in the force development process.

The constraint of operating costs has been the target of continuing complaint from ex-service⁽²⁴⁾ and other lobby groups who, in general, focused on closer-term prospects for the operational use of the ADF rather than the objective of modernising its capital base. This theme was adopted in opposition by the Coalition parties which, leading up to the election of 1996, placed more emphasis on increasing the readiness of the ADF. In the 1996-97 Budget a total of $125 million was diverted from administrative allocations within the Defence budget towards programs for improving the readiness of the ADF. However, improved readiness is not a cheap option. For instance, the cost to the 1999-2000 budget of last year's decision to bring 1 Division, based in Darwin, up to 28 days notice to move is estimated at $183 million.

The squeezing and relaxing of funding for operational activities has been a standard Defence budget management tool for over 30 years. At times this has had significant consequences. When RAN vessels were sent to support the UN blockade of Iraq in the Persian Gulf, prior to the Gulf War, an extensive list of systems and materiels, ranging from satellite communications to radar absorbent material, had to be purchased to bring RAN surface combat vessels up to a suitable state of readiness for possible involvement in modern naval warfare.⁽²⁵⁾

However, the approach remains relevant and increasing expenditure on Service readiness remains as difficult an option as before with the Defence budget at its current level. Despite the Government's objective of improving readiness, it was necessary to cut Navy fuel oil allocations for 1999-2000,⁽²⁶⁾ by amounts of perhaps up to 25 per cent. Restrictions on operational expenditures have occurred in other ways. In 1997 Defence decided to redirect $645 million of DRP savings towards redressing shortfalls in the logistics capacity of the ADF. By 1999 the amount for redirection had been reduced to a target amount of $436 million.⁽²⁷⁾

Sustainability

Sustainability has been equally affected by the direction of the Defence financial policy of the last quarter of a century. This process has often involved stockholding policy. In peace time, stockholding policy is contentious because many items are expensive, particularly guided weapons. Some equipments have limited shelf lives, raising issues of the appropriate balance between preparedness, training requirements and force structure development. What evidence that has been available suggests that the ADF has been able to implement only a restricted stockholding policy and that deficiencies in this risked imposing significant limitations on the ADF's performance in any combat which arose with insufficient warning to allow adequate restocking. ⁽²⁸⁾

In the event, this was among the most prominent concerns about the possible limitations of the ADF in performing its role within the INTERFET deployment on East Timor. These were seemingly confirmed in minor areas where the ADF had to 'borrow' equipment from the United States, including 4000 flack jackets.⁽²⁹⁾

Questions about the sustainability of the INTERFET deployment are merely the latest confirmation of difficulties with the sustainability of the ADF under current budgetary procedures. A former Chief of Air Staff, Air Marshall David Evans, commented in 1986 that the stock of Precision Guided Munitions (PGM) held by the RAAF would not last for even a day of high level operations.⁽³⁰⁾ That such limitations still have a practical effect was indicated by the leaking of documents showing that, at wartime rates, the RAAF would exhaust its supplies of ammunition after 30 days.⁽³¹⁾ Whilst the RAAF claims relate to the less likely circumstances of a conventional war, so limited is the RAN's current stock of missiles that its six FFG-7 class frigates fire an average of one Standard surface-to-air missile each during the year, despite the fact that a primary role of the vessels' is anti-air warfare. The Navy is apparently so constrained that it can fire only one Harpoon anti-shipping missile every two years. ⁽³²⁾

The Central Irony-Personnel Costs Continue to Absorb Efficiencies

Failure of the FSR

Whilst difficulties with the ADF's preparedness can be said to reflect financial stringency, it has been an explicit objective of financial policy to reduce the proportion of expenditure allocated to personnel costs. In this Defence has succeeded to some degree, reducing the proportion of outlay allocated to this area from more than 50 per cent of total expenditure in the early 1980s to an equivalent of around 40 per cent today.⁽³³⁾ Yet, despite the considerable reduction of employment in Defence, the objective of financial policy, to free funds for reapplication to force development objectives has not been achieved. In fact, the proportion of Defence expenditure allocated to personnel is no smaller today than was the case in 1989-90, before the implementation of the FSR, the first of the efficiency programs. The reason is that the majority of funds freed by management efficiencies have gone back to the area of pay and allowances.

The majority of funds freed by management efficiencies have gone back to the area of pay and allowances.

The adoption of agency bargaining in the Australian Public Service in the early 1990s, with pay rises largely funded through efficiencies from within existing budget allocations, was also applied to Defence. Consequently, the majority of the savings made under the FSR process were utilised in improving Service and civilian remuneration. The $340 million allocated from within the Defence budget for this⁽³⁴⁾ equated to 75 per cent of the savings generated by the FSR process up to the end of 1995-96.

This failure of financial policy was confirmed in comments of the then Chief of the Defence Force, Admiral Beaumont:

Table 2: Proportional Expenditure on Defence Budget Components

Adjusted to 1993-94 Accounting Changes. Percentage of Defence Expenditure

Source: Allan Shephard, Trends in Australian Defence: A Resources Survey, Australian Defence Studies Centre, 1999, Table 60, p.173.

False Premises of the DER

The DER was designed to attack this problem afresh. Minister McLachlan's comment that the defence organisation was at risk of having to cut capability has been cited above (p. 4).

However, we know now that the capacity of the DRP to reverse this situation was based, to a large degree, on the ADF being reduced to a personnel ceiling of 42 500.⁽³⁶⁾ This was eventually accepted by the Governmnet as too low and overthrown by strong urging from the ADF in favour of a personnel strength of 50 000.

The consequence is that the DRP will not meet the Minister's expectations that management efficiencies would allow Defence to avoid a potentially severe 'budget crisis ... after the turn of the century'.

The revision upwards will cost $632 million⁽³⁷⁾ at the maturity of the DRP,⁽³⁸⁾ (in around 2003-2004) around 62 per cent of the program's estimated savings from all sources of about $1 billion and 87 per cent of the reduced target of $730 million in recurrent savings which is now expected to be achieved.⁽³⁹⁾

The consequence is that the DRP will not meet the Minister's expectations that management efficiencies would allow Defence to avoid a potentially severe

There will now be precious little finance available to re-allocate to sustaining capabilities, let alone to allocate to the development of new ones through the capital equipment vote.

At its maturity, the DRP was expected to provide only an additional $139 million annually for major capital investment⁽⁴¹⁾ but the mathematics of personnel costs outlined above suggest that there is now less than $100 million available from DRP savings for all other purposes.

As this paper argues below, this is likely to be far too little to contribute significantly towards the cost of capital programs likely to be sought by the ADF. Indeed, pressure on the Defence budget is likely to increase to such an extent that even the preservation of a small amount for reinvestment in new capital programs must be considered unlikely.

Indeed, pressure on the Defence budget is likely to increase to such an extent that even the preservation of a small amount for reinvestment in new capital programs must be considered unlikely.

The Unaddressed Issue of Net Personnel and Operating Costs

There are other pressures diverting funding away from the equipment programs to greater than intended expenditures on personnel and ongoing operational costs. Defence has been slow to incorporate analysis of the Net Personnel and Operating Costs [NPOC] of new capabilities into its budget projections. At best, it seldom does this any earlier than the tender selection stage of a project. That is, it is not till Defence starts to talk to the preferred supplier of some newly selected equipment that the cost of operating it throughout its Service life is assessed and at this stage Defence is already committed to operating the approved capability. At worst, this process is not undertaken until the equipment is in Service and its logistics support program is being developed.⁽⁴²⁾ Consequently, there has been a consistent pattern of ADF capabilities costing more to operate than can be accommodated easily within the budget.

Defence has been forced to reallocate funding from other areas to cover the operating costs of high priority equipment programs, for which inadequate allocation has been allowed in forward financial planning. Programs for the Airborne Early Warning and Control [AEW&C] aircraft, helicopters for the ANZAC Class frigates, and coastal minehunters, for which such costs have been calculated, may add an additional $360 million per annum to the Defence budget when fully operational.⁽⁴³⁾

Defence has been forced to reallocate funding from other areas to cover the operating costs of high priority equipment programs, for which inadequate allocation has been allowed in forward financial planning.

The Defence executive has concluded that NPOC are growing at a rate which will make them 'comparable with total DRP savings by the end of the next decade'(i.e., about $760 million per annum by 2010).⁽⁴⁴⁾

A Consequence of Failure: Over-commitment to Capital Programs

Difficulty in handling the costs of defence labour has been a characteristic pattern of defence finance over the last quarter of a century. Operating costs have, on average, consumed a higher proportion of the budget during the 1990s than the 1980s. The impact of both these features has been exacerbated in both decades by Government not providing increases in total outlays projected by earlier Defence financial planning. Defence has often been slow to adjust its budgetary settings for the impact of these proportionately greater expenditures on its ability to allocate funds for new capital equipment.

Consequently, funding for equipment based capability development has fallen behind planning, to produce a current defence budgetary crisis. This has already assumed proportions which will inhibit the development of ADF capability for at least the next 10 years and will see some long awaited force structure developments further delayed or, perhaps, abandoned.

Over-commitment to new equipment programs has already assumed proportions which will inhibit the development of ADF capability for at least the next 10 years and will see some long awaited force structure developments further delayed or, perhaps, abandoned.

Throughout the 1990s, Defence has allowed commitments for new major capital equipment to accumulate at a rate which now averages 160 per cent greater than that at which it has increased the relevant component of annual appropriations. This is shown in Figure 1, which also demonstrates that the trend is likely to worsen under the revised 1999-2000 budgetary settings.

During this Financial Year, Defence has been forced to divert $756 million from major new capital equipment to cover other running costs:⁽⁴⁵⁾

• $380 million of it representing a real reduction in equipment ^{expenditure(46)and}, once again
• $359 million of the reduced expenditure on equipment was needed to fund rises in Defence labour costs.⁽⁴⁷⁾

As a result the revised Additional Estimates for 1999-2000 allocated an amount ($2 274.7 million) equal to only 5 per cent of the existing total commitments for new major capital equipment; in 1988-89 the budget allocation for new capital equipment programs represented about 8.5 per cent.

Figure 1

Source: Defence Portfolio Budget Statements for relevant years. Note that data for 1998-1999 does not appear to be available in any Department of Defence Publication

Figure 1 demonstrates that throughout the 1990s Defence has been committing itself to new equipment at a rate which has not been matched by increases in expenditure in the area. This pattern is not unusual at the beginning of a capital expansion program because of the lead times involved. However, the build up of the 1990s continued and, indeed, worsened after the mid-1990s even though the additional funding did not appear until 1998-99. Consequently, of the $46 billion cost of equipment programs currently under way, $20 billion remains to be spent.⁽⁴⁸⁾

Of the $46 billion cost of equipment programs currently under way, $20 billion remains to be spent.

These circumstances support media reports that the capital acquisition program is currently over stretched. The reports include stories of friction between Minister and Department over a potential $900 million blow-out in the 1999-2000 budget⁽⁴⁹⁾ and that the 'pink book' (which is the Defence management schedule for the entire equipment procurement program over a five year time frame), is oversubscribed by a total of $2.5 billion, equivalent to more than a full year's capital equipment expenditure.

This probably illustrates why Allan Hawke, Secretary of the Department, recently said that, 'Adding up all the projections is enough to badly frighten the horses',⁽⁵⁰⁾ and must have played a strong role in the Minister ordering a review of major equipment projects currently underway or being developed.

Until the consequences of budgetary commitment to a range of equipment programs which cannot be accommodated within the current structure of the Defence budget can be rectified, the nature of Defence's immediate financial situation is, to quote the Secretary, 'parlôus'.⁽⁵¹⁾

Furthermore, the over-commitment to major equipment programs has been exacerbated this current financial year. To the $20 billion carryover of spending on the capital program already under way have been added more than $5.1 billion for projects which were approved in the Budget context but were not then at contract. These include the AEW&C and light tactical transport aircraft, armoured vehicles and the FFG-7 frigate upgrade.⁽⁵²⁾ In addition, the cost of rectifying the combat data systems for the fleet of Collins class submarines has not been identified and may be substantial.

The inability of the current Defence budget to carry such expectations has already been shown by reductions in the planned expenditure for the FFG Upgrade and the light tactical aircraft during 1999-2000, which total $182.3 million⁽⁵³⁾ and by persistent rumours that one or other of the aircraft programs will be reduced. However, until some of the current equipment project catalogue is cut or significantly restructured, more then around $25 billion dollars will remain as the requirement to bring to fruition those projects for which contracts have been signed or the government has given approval.

Until recently, attention to problems with the Defence capital program had centred mostly on the issue of block obsolescence, in an apparent assumption that the equipment requirements of the ADF could be largely provided until that major hurdle arose. However, the current over-commitment to major equipment programs is the equivalent of more than 10 years of capital expenditure at current rates.

This circumstance makes no allowance for new programs which might be desired in the near future, such as the RAN's project to acquire three or four air warfare destroyers in a program which starts at a 'cheap' option of around $1 billion for ex-US Navy Kidd class vessels and increases to perhaps $6 billion for three new, locally built vessels.⁽⁵⁴⁾ Neither do the calculations allow the introduction of new capabilities that might be associated with advances in military technology, such as those of the so-called Revolution in Military Affairs. Such a circumstance could pose significant policy difficulties for government as there will be elements of potential new capabilities that may be desirable for maintenance of ADF interoperability with US Forces.

Consequently, unless a very significant restructuring of the current capital equipment program occurs, the Defence budget will be unable to cope with the problem of block obsolescence as funding demands build from about the mid-2000s.

In this sense, the current over-commitment to capital expenditure has brought the problem of block obsolescence forward and turned the policy issue of the future shape of the ADF into a current problem rather than one to be addressed later.

To make policy deliberation more difficult, these pressures on the equipment program have grown at a time when the established policy of diverting funding to this area may no longer be possible. Both established and more recent cost pressures (the latter largely associated with either the deployment in East Timor or its consequences) indicate that there is little chance of any funding being diverted to the capital component of the Defence budget in the foreseeable future. Indeed the greater chance is that the capital allocation will be reduced at times, as has been the case in 1999-2000.

The following section outlines the reasons why this probably will be the case.

Where to Now? The Continuing Sources of Stress in Defence Funding

In early March, the Prime Minister stated that the Government intended to increase defence spending 'from the year after next',⁽⁵⁵⁾ presumable from the 2001-2002 Budget. The projections that follow in this paper show that he has little choice unless the Government wants to make sudden and sweeping changes to current Defence policy and organisation.

The main issues arguing the necessity of additional funding are not the current over-commitment to capital programs nor the need to begin preparation for replacing equipment soon to become obsolete. Instead, the pressing immediate issues are those of personnel and operational costs which have both increased as a consequence of the Timor deployment and which will still be running through the budget process in 2001-2002. UNTAET (the United Nations Transitional Administration in East Timor) expects to be there for at least the next two years.

It would be surprising if room could be found within the limits of current fiscal policy for the Government to fund more than immediate demands in these areas. Although many of the costs associated with the Timor deployment will be funded in 2000-2001 by the additional levy through Medicare (and probably separately accounted in the 2000-2001 Budget), many of those costs will persist into 2001-2002 and beyond, making an increase in the Defence budget difficult to avoid on current settings.

Yet significant and demanding challenges are developing in the areas of personnel costs, operational expenditure and block obsolescence of ADF equipment (dealt with in the sections immediately below). The implication is that any likely level of defence funding will not remove the potential crisis in Australian defence nor the need for a re-thinking of policy.

Personnel Costs: The issue that will not go away

Despite the considerable reduction in Service and civilian personnel over the last 15 years, personnel costs are not a significantly lower proportion of the budget. They will remain a critical source of pressure in the budget and a continuing challenge to policy.

Although an argument in favour of modern defence equipment is that it requires less personnel to operate, the levels of skill demanded by these systems has increased. Defence management has recognised that this factor would be 'reflected in expectations for remuneration and other things in personnel costs in the future'.⁽⁵⁶⁾ In fact, it has proved increasingly difficult to attract new recruits and to retain experienced service personnel, even with increased salary levels. The ADF has had to resort to bonuses for such categories as pilots and submariners to reduce the rate of resignations from the Services. Over the last three years acceptances at the Australian Defence Force Academy, the training institution for future officers for all three Services, have dropped from 99 per cent to 65 per cent, a trend attributed by the assistant Minister to competition from greater job opportunities as the economy continues to grow strongly.⁽⁵⁷⁾

Such developments provide a prima facie case that the ADF is re-positioning itself in the labour market and having to compete for an increasingly expensive category of worker. There are indications that the extent of this movement may be significant. It appears that remuneration in defence industry companies, which to date have functioned largely by wooing Service personnel, is in some areas paying $5000 to $20 000 less than comparable civilian oriented industry.⁽⁵⁸⁾ The implication is that, as access to ex-Service personnel reduces as management efficiencies work their way through the Defence organisation, rates in private industries will increase and continue to place pressure on Defence labour costs. If so, the budgetary problem of defence labour costs is not necessarily a short-term planning issue but the symptoms of a more difficult long-term problem.

The consequences of the labour market problem for the Defence budget are complicated by the machinery for implementing the Government's policy on public sector wages growth. Each financial year, an adjustment to the Defence budget is allowed by the Department of Finance and Administration (DoFA) to compensate for price increases in personnel costs. That is, an index is applied to adjust the 'real' cost of this component. In practice, the arrangement has understated the rising price of defence labour significantly.⁽⁵⁹⁾ When the parliamentary Joint Standing Committee on Foreign Affairs, Defence and Trade (JSCFADT) examined this issue, defence full-time labour costs were increasing at a rate of around 4 per cent per annum and had done so for the past 10 years-the index then averaged only around 1.5 per cent. This problem continues unchanged at present, although the extent of wage increases may be a little more moderate.⁽⁶⁰⁾

The impact of this discrepancy will be compounded by the failure of efforts to reduce the level of Service employment. Not only has the personnel planning base of the DER been raised but the Government now has decided to increase the 50 000 personnel ceiling by 3500.⁽⁶¹⁾ Although the decision is to be reviewed in two years, this will be in the context of revised strategic policy and it is likely that this will support the maintenance of a larger ADF. At the current average annual cost of Service personnel, of $70 000, these two decisions to add to personnel numbers increase the personnel budget by around $770 million. At the maturity of the DRP process these additional personnel costs will have exceeded $900 million, over 20 per cent greater than the recurrent savings now expected to be realised.⁽⁶²⁾

At the maturity of the DRP process additional personnel costs will have exceeded $900 million, over 20 per cent greater than the recurrent savings now expected to be realised.

Figure 2 is an illustration of what might happen if the costs of this increased labour force were to grow over the next 20 years at an average annual rate of 4 per cent with only partial supplementation and the remaining costs to be absorbed by the Defence budget. By 2020 total labour costs would have risen to almost $10.2 billion per annum against a budget that over the same period would have grown to less than $13.3 million. Almost 36 per cent of total labour costs, $3.9 billion, would have to be drawn from other areas of the budget. This is an amount 71 per cent larger than the revised 1999-2000 allocation for majr new equipment and 38 per cent greater than that ($2 822.1 million) for all capital expenditure^..

Almost 36 per cent of total labour costs, $3.9 billion, would have to be drawn from other areas of the budget.

Figure 2

Source: Foreign Affairs, Defence and Trade Group, Information and Research Services, Department of the Parliamentary Library, April 2000.

Note: This projection assumes that the rate of increase in personnel salaries averages 4 per cent over the period; the rate of compensation received from Department of Finance averages only 1.5 per cent.

This extrapolation is not a prediction that personnel costs will consume most of defence finance by 2020. If this level of unsupplemented wage increases were to persist without adequate increases in the Defence budget, most Defence activities would have ceased. As Figure 5 suggests, in these circumstances all capital expenditures would disappear about 2010. If there is no significant adjustment to either (or both) defence policy and finance in the near future, one can expect that the current state of over-commitment in capital programs, coupled with an increasingly obvious decline in capital funding, will produce a political crisis in about 2005 which will force significant policy change.

What the extrapolation does show is that the cost of salaries remains a central problem of policy, whose solution will have significant bearing both on the size of future Defence budgets and on their capacity to support a real contribution to national security.

Consequences of Timor: Greater Emphasis on Operational Expenditure?

As discussed above, a consistent tool of defence financial policy for the past quarter of a century has been the frequent restriction of expenditures in many areas supporting ADF operational activities. Freedom to use this approach may be more restricted in the future. The consistent growth of NPOC has been mentioned above (p. 12) as a factor likely to require an additional $760 million per annum by 2010. Furthermore, the INTERFET deployment may come to be seen as marking a change in Australia's strategic circumstances, the consequence of which may be seen as a need for increased operational readiness and sustainability by the ADF.

It will cost the ADF $907 million to operate in East Timor during 1999-2000 and $3562 million over the 4 years projected for the full period of Australian involvement.⁽⁶³⁾ Such a sharp realisation of the full extent of costs involved in operational deployment⁽⁶⁴⁾ adds another element to the problems of funding Australia's defence. When operational deployment is unlikely, ADF units train so far below their potential capacity that it is easy to forget that annual Defence budgets could be increased by some billions of dollars if ADF activity rates were not held back, most often simply to manage expenditure.

It is not unusual for the operational activities of defence forces to be under-funded when operational deployment is less likely. Governments rely on the professional expertise of their Service advisers to achieve the best compromise between the training requirements of their Forces and the elements facilitating operational deployment and the need to carefully allocate funds across a range of competing defence requirements.

On the public information available about the performance of the ADF in East Timor, the balance reached by the eve of the operation appears to have been pretty right, at least in the case of readiness and at least for that type of operation. However, it seems equally clear that the commitment was inadequately backed as far as sustainability was concerned and, indeed, the Government has since moved to rectify the situation by expanding Army and Airforce numbers and supplementing ancillary stores and equipment, as announced in the Prime Minister's statement of November 1999.

A consequence of the Timor deployment probably will be to limit the 'traditional' policy of restricting expenditure on operational expenses in many areas of ADF activity for at least several years. Indeed, analysis of the Timor deployment may indicate that strengthening of ADF personnel and preparedness on a continuing basis is advisable and this may emerge as policy from the Government's strategic review process during 2000.

A consequence of the Timor deployment probably will be to limit the 'traditional' policy of restricting expenditure on operational expenses in many areas of ADF activity for at least several years.

If so, those ancillary costs of the INTERFET deployment will become a recurrent feature of the Defence budget, a factor further limiting prospects for the development of equipment-based ADF capabilities.

An Improbable Task: Funding the Replacement of Obsolescence Equipment

The third major pressure on the Defence budget is the developing problem of the block obsolescence of major components of the ADF's equipment inventory, usually seen as starting in about 2007. Among the systems to be retired in the period from then to around 2015 are:

• FFG-7 frigates
• F18 fighter aircraft
• P3C maritime patrol aircraft
• C-130H transport aircraft
• amphibious and afloat support ships
• Army's transport vehicle fleet, and
• Army small arms.

The F-111 strike aircraft will retire between 2015 and 2020. In addition expenditure will be required to extend the Service lives of equipment such as the Blackhawk and Seahawk helicopters and armoured vehicles if they are to serve to 2020.⁽⁶⁵⁾

What makes this coming period significant in defence planning terms is not simply the potential costs involved but that the equipment supports many of the central capabilities of the ADF. Failure to suitably replace equipment during this period, in most cases, will mean a loss of defence capability. That is, there will be some military roles which the ADF will cease to be able to perform.

Failure to suitably replace equipment during this period, in most cases, will mean a loss of defence capability. That is, there will be some military roles which the ADF will cease to be able to perform.

It is seldom that the pink book has not been oversubscribed. Management processes are frequently required to work through the issue of prioritising programs and cutting proposals to fit the budget. The current over-commitment on capital programs indicates that this form of discipline is becoming harder to apply and the extent of the cost pressures associated with the block obsolescence issue are such that management processes will not solve the problem.

Recently, the Secretary of the Department put the cost of replacing this inventory up to the year 2020 at between $88 and $106 billion.⁽⁶⁶⁾ He added that the process of replacing this equipment would be complicated by the need to keep abreast of the development of regional capabilities and that, historically, the cost of such capability enhancement could increase in some cases by 5 per cent per annum in real terms.⁽⁶⁷⁾ This can be taken as an estimate of the additional cost where the ADF wishes to address the block obsolescence problem by procurement of equipment with significantly improved performance.

The cost of coping with the block obsolescence issue will be interspersed with, and additional to, the unexpended costs of equipment programs underway or approved. As stated above, these are currently about $25 billion. It seems safe to presume that the eventual costs of block obsolescence will be close to the top end of the Secretary's scale. Equipment costs have often been double the initial Departmental estimate by the time that a contract with the supplier has been negotiated.

If, for the sake of illustration, it is assumed that Defence were to try to purchase all the capital equipment involved in the over-commitment and in block obsolescence, it would be required to spend $131 billion over the next 20 years. Such a feat would require Defence to spend $6450 million per annum on major capital equipment, starting next financial year. This is without making allowance for the inflation of costs incurred when improving levels of military capability. Expenditure of this level would be 183 per cent greater than the revised allocation to major capital equipment, of $2275 million, in the 1999-2000 Budget.

Expenditure at this level is clearly impossible, especially in the near future.

Expenditure at this level is clearly impossible, especially in the near future. However, if the ADF wishes to retain its current and projected capabilities it must find some way of attaining most of its equipment planning objectives or alternative methods of sustaining the capabilities which are currently supported by its equipment inventory. Normally, government can be expected to respond as the Minister has done and review the Department's equipment procurement program. The options recommended by the Department will include all the usual tactics. Indeed, some of them are popping up already:

• second hand equipment could be purchased from the US deferring, let's say, a destroyer acquisition program
• service lives of platforms will be extended, perhaps C-130H aircraft serving out towards 40 years or FFG-7s sailing on into the 2020s
• capability upgrades will be deferred, reduced or cancelled to allow spending on new platforms
• commercially provided options will be tried and already the Fremantle replacement program appears likely to be leased from the commercial market; later, perhaps ADF air freighting, aerial refueling capacity and general service vehicle fleets may be hired
• this process could go further and some functions such as coastal surveillance hived off onto other agencies.

Consequently, some of the options presented by the Department over the next 20 years will probably also include shedding of ADF capabilities and roles.

However, as is demonstrated in the final section, the financial pressures on the Defence budget are so severe that unusual, innovative or desperate approaches to developing equipment programs will not be sufficient to fund all of those that the ADF requires to sustain it existing range of capabilities. Consequently, some of the options presented by the Department over the next 20 years will probably also include shedding of ADF capabilities and roles.

That Defence is already re-evaluating its capital program and considering the removal of items indicates that the issues of sustaining ADF capabilities are current, and currently serious. In terms of planning Australia's strategic policy the issue of block obsolescence has become a problem of the moment, not a matter which can be dealt with in ten years. The dilemma for policy development will be how to sustain the ADF's ability to support national security with military capabilities when many of the equipments that currently support those capabilities will no longer be available.

The dilemma for policy development will be how to sustain the ADF's ability to support national security with military capabilities when many of the equipments that currently support those capabilities will no longer be available.

Prospects for the Defence Budget

The issue now is to consider the extent of the impact that these cost factors will have. This section provides a number of illustrations of what might happen to the Defence budget if the trends that have been identified above were allowed to develop unchecked. In reality, this is not likely to eventuate because, in combination, the cost pressures are so destructive of current policy settings that they eventually would cause the collapse of either fiscal or defence policy.

Not that the existence of potentially damaging cost pressures is a new awareness for Defence. The 1994 white paper Defence of Australia, indicated that Defence was not sanguine that the planned procurement programs could be funded from the then expected levels of budgetary allocations and efficiency gains. DA94 argued that real growth in defence funding, equivalent to the growth rate of GDP, would be necessary from later in the decade or, as it quaintly expressed it, 'the Defence budget will not need to grow faster than the economy as a whole.'⁽⁶⁸⁾ The rate of such increase would have been intended to maintain the value of the Defence budget at two per cent of GDP up to the turn, and into to first decade, of the next century.

Since the election of the Howard Government both the then Minister⁽⁶⁹⁾ and the DER Senior Review Panel,⁽⁷⁰⁾ have made similar observations-that real increases in defence outlays would be required in two to three years (i.e. from 1997) if ADF capabilities were to be sustained.

This is not an unusual position in defence policy development. There has been something of a tendency for white papers to look at financial feasibility only over the short-term and assume that something will turn up over the longer.

This may have something to do with the circumstance that the time frames of conventional public sector financial planning are totally inadequate for the implementation of defence policy. During the three year framework of Forward Estimates few of the military capability programs approved by a white paper will have been completed. Certainly, most of the equipment based capability programs will not even have been ordered. For Defence, the longer term of the policy framework has been around ten years and, historically, the budget to fund the long-term view has never been available. The tools of public sector managerialism, such as cascaded planning and accrual accounting, are irrelevant against this central fact.

The tools of public sector managerialism, such as cascaded planning and accrual accounting, are irrelevant against this central fact.

Limited awareness of these factors reduces understanding, certainly in the public arena and probably beyond the sphere of those Ministers concerned with national security, of the scope and duration of financial obligation involved in implementing defence policy. The following section attempts to illustrate the commitment involved with current policy. Below are several extrapolations of the major current trends in defence finance that have been outlined above. They illustrate what are probably the extremes of the situation but this is necessary to understand the range of dangers which any adjustment of current policy will have to avoid.

Figure 3

Source: Foreign Affairs, Defence and Trade Group, Information and Research Services, Department of the Parliamentary Library, April 2000.

Figure 3 constructs an example of the situation where the pressures on the Defence budget identified above are allowed to developed unchecked. The Figure distinguishes personnel and equipment costs as separate categories and for simplicity combines all other elements of Defence expenditure into a third. Personnel costs are assumed to increase at a rate of 4 per cent per annum whilst the expenditure on equipment shows the effect of attempting to pay for the entire $131 billion worth of programs over the next 20 years. The component of all other Defence expenditure is as in the 1999-2000 Budget except for the addition of the non-personnel costs of the expansion of the ADF, the estimated additional cost of unfunded increases in NPOC and, to illustrate the effects that a policy to increase the preparedness of the ADF might have, a figure of $500 million per annum from 2003.

If there were ever to be a situation where all these cost drivers were allowed to run unchecked, the cost of personnel would still remains the significant challenge for policy, costing over $10.2 billion per annum by 2020. Expenditure on major equipment would probably reach the same level at that time but the exact amount paid out in any particular year would be a function of the phasing of expenditures and the progress of particular projects from year to year.

The cost of all the other components of defence expenditure would be just below $6 billion. Whilst this seems less significant than the other two components, the assumption is that, to sustain a policy calling for greater operational preparedness, this component of the budget could not be 'raided' to offset the increases in personnel and equipment costs.

In consequence, the total Defence budget in cash terms would cost more than $26 billion (in 1999-2000 nominal prices) by 2020.

Figure 4 compares a notional Defence budget with all cost growth factors included as shown in Figure 3, with a budget that has no real growth over the next 20 years and with a notional budget which increases annually at the rate of 3.5 per cent. The 'no growth' example is an extrapolation of the 1999-2000 budget with no sustained increase in operating costs following the Timor deployment. However, it allows for the standard DoFA supplementation of wage increases (1.5 per cent) for an ADF of 53 500 personnel.

Figure 4

Source: Foreign Affairs, Defence and Trade Group, Information and Research Services, Department of the Parliamentary Library, April 2000.

The $26.4 billion that would be spent on defence by 2020 in this example is almost twice the $13.3 billion that would be available if the budget were to continue without real increase

This figure illustrates the consequences of allowing the current cost pressures within the Defence budget to develop unchecked. The $26.4 billion that would be spent on defence by 2020 in this example is almost twice the $13.3 billion that would be available if the budget were to continue without real increase. The expenditure in this projection is also more than $4 billion per annum higher than the $22 billion that would be available if the Defence budget were increased at the rate of Treasury's projection of the long-term GDP growth trend line, at 3.5 per cent. In fact, 3.5 per cent growth in defence outlay is a figure that has seldom been reached, and not long sustained, in defence funding over the last quarter of a century.

The question to be asked is whether there is any circumstance in the foreseeable future where government would be willing to provide funding ranging from an additional $9 to $13 billion per annum for defence? To do so would mean abandoning fiscal policy of producing budget surpluses and reducing government debt. To even contemplate such a policy would be complicated by contemporary expectations that increases in government revenues should be returned in the form of tax cuts.

The question to be asked is whether there is any circumstance in the foreseeable future where government would be willing to provide funding ranging from an additional $9 to $13 billion per annum for defence?

The conclusion must be that the types of programs expected by Defence under its current policy settings can not be funded with the budget at its current size and that it remains doubtful that government will increase the budget sufficiently to fund them all. Neither are there mechanisms that might be used to correct the situation. The DRP, supposed to give relief and provide the polemical basis for arguing real increases in the budget, is unlikely to now release any significant funding for new equipment nor for many areas beyond personnel costs.

The lesson is that managerialist efficiencies are fine for improving the performance of Defence but are no substitute for feasible and workable policy.

The consequences of this situation, where neither sufficient funding increases nor effective management improvements will be forthcoming, are not reassuring. The current situation is clearly not sustainable. In a scenario where the Defence budget was not increased and personnel and operating costs grew as shown in Figure 3, further savings will be required from areas such as equipment procurement to stay within budget appropriations. These reductions would soon become so significant that they would terminate most defence activities.

Figure 5

Source: Foreign Affairs, Defence and Trade Group, Information and Research Services, Department of the Parliamentary Library, April 2000.

Figure 5 shows the consequences of the Defence budget continuing with no real growth throughout the next 20 years but with cost growth factors allowed to continue unchecked.

In these circumstances personnel costs come to consume 77 per cent of funding by 2020. Well before this, however, in about 2009, there is no longer any finance left to purchase new capital equipment. By 2020 even the use of old equipment becomes difficult as the amount available for all other defence expenditures is effectively halved. In such circumstances the ADF would come to resemble areas of the Papua New Guinea public service, where wages are paid but little is done because adequate operational funding is available for only short periods of the financial year.

It appears that, as the last well springs of defence managerialism are being [w]rung out, defence policy is entering a period where some very difficult choices on ADF roles and capabilities are required.

Conclusion

Now that Government can no longer squeeze sufficient savings from Defence to meet the costs of sustaining all current ADF capabilities and is unlikely to wish to fund all of them sufficiently by other means, the need for effective policy supported by public debate becomes unavoidable. This will make the Government's forthcoming defence white paper one of the most important ever delivered.

It can not be argued that the calculations presented in this paper will be precisely those figures which will be seen over the next 20 years. Much will happen in that time which will not be expected. Nonetheless, the trends identified in this paper are so definite that it is clear that the ADF cannot expect to be performing all its current roles by the end of the second decade of the next century. Selecting which roles should be removed and which developed will be a difficult and, in the light of history, an acrimonious process. To be an effective arbiter in these disputes, the new white paper will have to provide a very fundamental analysis of Australia's national security needs and a precisely defined role for military forces within that. Selecting the critical objectives of defence policy in a world where financial pressures are further limiting Australia's options will not be easy.

Endnotes

2. For more on issues involved in the deployment of Australian forces in East Timor see: Dr Frank Frost and Dr Adam Cobb, The Future of East Timor: Major Current Issues, Research Paper No. 21 1998-99, Information and Research Services, Department of the Parliamentary Library, Canberra, 24 May 1999 and Dr Adam Cobb, East Timor and Australia's Security Role: Issues and Scenarios, Current Issues Brief No. 3 1999-2000, Information and Research Services, Department of the Parliamentary Library, 21 September 1999.

3. The Hon. Kim C. Beazley, MP, Minister for Defence, 'After the White Paper-The Challenge of Management', Address to the National Press Club, Canberra, 25 March 1987, p. 6ff.

4. Department of Defence, The Defence of Australia 1987, AGPS, Canberra, 1987, p. 112.

5. Department of Defence, Force Structure Review 1991, AGPS, Canberra, 1991, p. 3.

6. Defence is able to undertake such efficiency programs because of the special treatment of the Defence Budget which, unlike those of most other Commonwealth entities, is a global budget. For an explanation of Defence budget features see: Gary Brown and Derek Woolner, 'Should the Defence Budget be Cut? Arguments for and Against', Current Issues Brief no. 6 1996-97, Parliamentary Research Service, 9 September 1996, pp. 4-7.

7. Department of Defence, Future Directions for the Management of Australia's Defence, Secretariat Papers, Paper 2, p. 17.

8. Department of Defence, Defending Australia, AGPS, Canberra, 1994, p. 146ff.

9. The Hon. Ian McLachlan, AO, MP, Minister for Defence, 'Australian Defence Policy After the Year 2000', address to conference The New Security Agenda in the Asia-Pacific Region, Canberra, 3 May 1966, in Defender, Winter 1996, p. 7.

10. The Hon Ian McLachlan, AO, MP, Minister for Defence, Ministerial Statement, 'The Defence Reform Program', 30 September 1997, p. 2.

11. Department of Defence, Secretariat Papers, Paper 9, p. 229.

12. op. cit., Paper 14, p. 387 and,

13. As part of the FSR, a number of initiatives to improve the management of defence activities were established. These included the Commercial Support Program, the Defence Regional Support Review, the Defence Logistics Redevelopment Project, the Supply Systems Redevelopment Project and the Financial Systems Redevelopment Project which included concepts subsequently approved by the DER, such as nationally organised systems, expanded single Service management for common ADF functions and devolved authority for categories of purchasing.

14. Department of Defence, 'Defence submission to the Joint Standing Committee on Foreign Affairs, Defence and Trade, Inquiry into the level of funding required for the defence of Australia', in JSCFADT, Defence Sub-Committee, Submissions, Volume 1, Canberra, July 1997, p. 286.

15. Department of Defence, Secretariat Papers, Paper 2, p. 18.

16. op. cit., Paper 9, 228-231.

17. Joint Standing Committee on Foreign Affairs, Defence and Trade, Defence Sub-Committee, Submissions, Volume 1, loc. cit.

18. The Hon. Ian McLachlan, 'The Defence Reform Program', op. cit., p. 5.

19. Defence Report 1983-84, 'Functional distribution of Defence manpower at 30 June 1984', p. 112, and Defence Report 1989-90, Table C, p. 8.

20. Department of Defence, Defence Report and Defence Annual Report for relevant years.

21. Department of Defence, Australian Defence, Canberra, November 1976, pp. 59-60.

22. For instance, when Army numbers were reduced by 677 to 32 000 in 1985, the impact was sufficiently severe to force the disbandment of some units and the amalgamation of Regular and Reserve units. The then Chief of the General Staff (later to become Chief of the Defence Force) General Peter Gration commented that these 'reductions were in line with the budgetary strategy of placing maximum emphasis on procuring capital equipment like weapons, vehicles and radios'. 'Army manpower reductions'. Defence News Release, No.156/85, 11 October 1985.

23. The Auditor General, Management of Australian Defence Force Preparedness, AGPS, April 1996, p. 7.

24. Department of Defence, Secretariate Papers, Paper 5, p. 81.

25. This is because serving personnel generally do not comment on the effects of Governmnet policy; senior officers who reveal the consequences of reduced operational outlays usually do so in retirement. One exception was Lieutenant General Laurie O'Donnell, then Chief of the General Staff, who publicised the decision to reduced Army operational activities by around 10 per cent following cuts of $39 million to operational outlays resulting from a requirement that Army absorb budgetary costs, including pay rises. 'Cuts in operating costs, Army, 15 September 1988, and 'Operating costs', Army, 8 December 1988.

26. Brown, Australia's Security, Issues for the New Century, pp.71-72.

27. 'Jervis Bay's patrol task', Navy News, 12 July 1999.

28. Australian National Audit Office, Management of Major Equipment Acquisition Projects, Canberra, October 1999, p. 160.

29. Paul Dibb, Review of Australia's defence capabilities, AGPS, Canberra, p. 96, The Auditor General, Management of Australian Defence Force Preparedness, p. 53.

30. Christopher Jay, 'Combat gear will need expanding', Financial Review, 1 October 1999.

31. S. D. Evans, Air Marshal, RAAF (Ret), 'Air Power in the Defence of Australia: The Strategic Context', in Des Ball, ed., Air Power Global Developments and Australian Perspectives, Pergamon Press, Sydney, 1988, p. 122.

32. Charles Miranda, 'RAAF" almost out of ammo"', The Advertiser, 11 April 1997.

33. Daniel Lewis, 'Fire one! And that's it for another year', Sydney Morning Herald, 1 June 1995.

34. Comparison over time of the proportion of the Defence Budget allocated to personnel is difficult. Changes were made in 1993-94 that altered the treatment of military superannuation in the Commonwealth budget. This variation produces a proportion of expenditure allocated to personnel which is approximately 5 percentage points less than was the case before the change. See, Allan Shephard, Trends in Australian Defence, A Resources Survey, Australian Defence Studies Centre, Canberra, 1999, p.164ff.

35. Joint Standing Committee on Foreign Affairs, Defence and Trade, Defence Sub-Committee, Submissions, Volume 1, July 1997, p. 285.

36. 'Five-year rolling Budget "will help planning"', Australian Defence Reporter, August 1995, p. 14.

37. Department of Defence, Portfolio Budget Statements 1998-99 Defence Portfolio, Canberra, May 1998, p. 15.

38. Department of Defence, Defence Annual Report 1998-99, Canberra, October 1999, p. 17.

39. The concept of 'maturity' of the DRP does not refer to a fixed time but rather to a point where major efficiency initiatives have been completed. This may be variable depending, in the case of recurrent savings on market testing of activities and, in the case of one-off savings on variations in the time required to close, and dispose of, functions. These time scales may be altered by decisions of government, such as embargoes on the sale of facilities in regional Australia. The latest estimate for the DRP reaching maturity is 'the 2002-03 period, and slightly beyond that' in the case of recurrent savings and 'about 2004-05' for one-off savings. Rod Tonkin, Deputy Secretary, Resources and Management, Department of Defence, 'Consideration of Additional Estimates', Foreign Affairs, Defence and Trade Legislation Committee, Senate Proof Committee Hansard, Canberra, 9 February 2000, p. FAD&T22.

40. Dr Allan Hawke, What's the Matter-A Due Diligence Report, Address to the Defence Watch Seminar, Canberra, 17 February 2000, p. 5.

41. The Hon. Ian McLachlan, 'The Defence Reform Program', p. 2.

42. Department of Defence, Defence Annual Report 1998-99, p. 16.

43. Australian National Audit Office, op. cit., pp. 159-160.

44. Joint Standing Committee on Foreign Affairs, Defence and Trade, Defence Sub-Committee, Submissions, Volume 1, op. cit., p. 287.

45. The $760 million figure is drawn from the Auditor General's analysis. Australian National Audit Office, op. cit., Figure 9 'Net Personnel and Operating Costs', p. 160.

46. Department of Defence, Portfolio Additional Estimates Statements 1999-2000, Defence Portfolio, Table 2.7 Capital Budget-Departmental, Canberra, February 2000, p. 37.

47. Of the reduction $332m represents a bookkeeping transfer of expenditures from assets to inventory. Dr Ian Williams, First Assistant Secretary, Resources and Financial Programs, Department of Defence, Foreign Affairs, Defence and Trade Legislation Committee, op. cit., p.FAD&T68, Department of Defence, Portfolio Additional Estimates Statements 1999-2000, Defence Portfolio, Table 2.5 Budgeted Statement of Cashflows-Departmental, p. 35

48. Foreign Affairs, Defence and Trade Legislation Committee, loc. cit.

49. Department of Defence, Portfolio Additional Estimates Statements 1999-2000, Defence Portfolio, p. 117.

50. 'No overspend in 1999-2000 Budget', Australian Defence Reporter, 10 June 1999, and Ian McPhedran, 'Huge defence blow-out foiled', Daily Telegraph, 30 June 1999. The latter alleged that the cumulative over-run effect of allowing the additional $900 million to be included in the 1999-2000 Budget would have been to raise expenditures over this and successive budgets by $2 billion.

51. Dr Allan Hawke, What's the Matter-A Due Diligence Report, p. 3.

52. ibid.

53. Peter La Franchi, 'Funding boost for missiles and NBC defence in Australian budget', Asian Military Review, June-July 1999, p. 41.

54. Department of Defence, Portfolio Additional Estimates Statements 1999-2000, Defence Portfolio, p. 14.

55. Peter La Franchi, 'New destroyers to focus on air warfare', Australian Financial Review, 7 January 2000.

56. Geoffrey Barker, 'PM's timetable for defence rise', Australian Financial Review, 3 March 2000.

57. JSCFADT, Defence Sub-Committee, Transcript, 4 August 1997, p. 9.

58. Large drop in ADFA intake', Canberra Times, 23 March 2000

59. Jan Lowe, 'Poor pay makes a bad defence', Australian Defence Magazine, December1999-January 2000, p. 26.

60. JSCFADT, op. cit., pp. 65-66. The Committee received evidence that if this relationship pertains over the next 10 years Defence will outlay an additional $5 billion in labour costs over the period. However, I have been unable to find data that replicates this rate of increase and have used that in the JSCFADT Report throughout.

61. Rod Tonkin, Deputy Secretary, Resources and Management, stated during Additional Estimates that 'We have negotiated and implemented a pay rise for the ADF of 3.5 per cent per annum. Staff on the civilian side are presently voting on the same offer. The difference between 1.5 and 3.5 has to be found out of the Defence Budget by increased efficiencies or offsets'. 'Consideration of Additional Estimates', Foreign Affairs, Defence and Trade Legislation Committee, Senate Proof Committee Hansard, Canberra, 9 February 2000, p. FAD&T74.

62. The Hon. J. W. Howard, Statement on East Timor, 23 November, 1999, pp. 6-7.

63. Dr Allan Hawke, What's the Matter-A Due Diligence Report, p. 5.

64. The Hon. J. W. Howard, Statement on East Timor, East Timor Budgetary Costs.

65. See, Australian Army, The Australian Army Submission to the JSCFADT Inquiry, Canberra, 1999, pp. 5-6, for a conceptual model of the components of the cost increases involved in moving from a training situation to operational levels of capability.

66. Dr Allan Hawke, Defence-The State of the Nation, Address to the United Services Institute of the ACT, Canberra, 2 February 2000, p. 22.

67. ibid.

68. ibid., p. 23.

69. Defending Australia, p. 146.

70. Don Greenlees, 'McLachlan calls for more defence funds', The Weekend Australian, 1 March 1997.

71. Report of the Defence Efficiency Review, Future Directions for the Management of Australia's Defence, p. 7.

 

 

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