Our Defence Capabilities

The Commonwealth Government recently released its Defence White Paper. The strategy within that statement was underpinned by a significant growth in Australia's defence expenditure, scheduled to grow to two percent of Australia's GDP by 2020-21. This implies additional funds to Defence somewhere in the order of $30 billion over the period to 2025-26 which will enable just under $200 billion of new investment in our Defence capabilities over this period.

Of course, spending of this magnitude involves careful and considered assessment. The Defence Industry Policy Statement, released with the White Paper, highlights the importance of Australian industry in the future development plans for our national security.

The Cadence Economics team, particularly through the addition of Dr Rob Bourke, has undertaken a broad and extensive body of work relating to the Defence industry.

Economic impact assessments

Cadence Economics recently assisted the Department of Defence in undertaking one of the most important and complex forms of industry analysis - an economic impact study of the Future Submarine project (SEA 1000). The study is the single most comprehensive assessment of industry impact prepared for any Defence capital equipment project and the largest example of industry analysis undertaken by the Department for many years.

Other economic impact assessments using applied general equilibrium modelling have considered the economic impact of a number of major Defence capital equipment projects including those for military vehicles, radar networks and naval helicopters. In all cases, the studies formed the basis of Defence advice to Government on the economic effects of project expenditure. For example, an economic impact assessment of helicopter assembly facilities for Australian Aerospace Limited included a detailed assessment of the net economic benefits to Australia, based on domestic or foreign build.

The submarine reports in particular dealt at some length with the direct, indirect and spillover effects of expenditure at national, state and regional levels and extended to include a broader consideration of how defence projects compared against other forms of Government expenditure in affecting economic growth.

Industry Capability Analysis

Our staff have been involved in a series of eight individual studies assessed the ability of defence industry to deliver the capabilities considered by Defence to be of the highest military-strategic value to Australia. Ranging from electronic warfare to ship dry docking and submarine combat systems, the studies compared Defence's short and longer term demand for defence industry capabilities against Australian industry's ability to supply, taking into account the Department's current and expected procurement plans and industry's development potential. The studies were the first of their kind conducted in Australia and involved extensive contact with both larger and smaller defence manufacturers.

Analysis of cost drivers

We have been involved in a range of studies considering cost drivers for Defence equipment. For example, when considering equipment cost we undertook a series of studies that included an Australian assessment and international literature review of the economic, technological and military-strategic factors which combine to influence the long term costs of advanced weapons systems including systems operated by Australia's Defence Forces. It included an extensive review of why the unit price of such systems has tended to increase steadily over time despite significant improvements on manufacturing productivity. The studies included an extensive review of historical trends in the unit prices for major naval, air and land weapons platforms.

Another study explored the various options for estimating the potential exposure of Defence to inflationary pressures relating to the Department's capital equipment acquisitions and included the identification of Australian price indexes which might be suitable for Defence to use for the purpose of adjusting contract prices for the effects of inflation. It involved a comprehensive assessment of how available prices indexes are structured and their relative advantages and disadvantages when applied in a defence procurement context. The approach to indexation recommended by the study was subsequently adopted for all major Departmental capital equipment acquisition and sustainment projects.

We also examined the various options which exist for structuring the pricing and costing elements of Defence capital equipment projects including fixed price contracts, cost-plus contracts and various types of incentive contracts. The study included a comprehensive assessment of the relative economic merits of each type of contracting as well as the types of projects to which each type of contract might best be suited. It extended to an examination of how price and cost regulation for sole source procurements in a Defence environment differs from regulation in other areas of the economy including public utilities.

Industry Performance Indicators

This work developed a comprehensive system for benchmarking both the project and financial performance of Australia's leading defence contractors, for report to senior Defence decision makers. It included not only a mechanism for progressively evaluating whether contractor performance at a project level had improved or deteriorated over time (supported by a 360 degree feed-back mechanism through which industry assessed Defence as a project manager) but went on to establish whether positive/negative contract performance was linked to positive/negative financial rewards for industry. The system was adopted by Defence for all major capital equipment projects.