SDSR 2015 – The 2% Version – Part 1

A Guest Post By Martin 

We have become accustom to defence reviews being simply budget cutting, salami slicing exercises dressed up as strategy. This is principally due to the fact that over the last 25 years the armed forces budget as a percentage of GDP has been cut in half, from roughly 4% to 2%.

Many of the historic cuts took place at times when government finances were in a far better shape than they are today. The prevailing wisdom at the MOD seems to be assuming a further cut to the forces budget of 10% after the next SDSR. However there are three potential factors which may see SDSR 2015 become not a budget cutting exercise but a budget increasing exercise.

The first potential factor is the UK dropping below the NATO threshold of 2% of GDP on military spending. If you had asked me a year ago I would have said that there was no chance of the UK ever failing to make the minimum NATO spending commitment. The UK has even led the campaign amongst European NATO members to meet this target. However even as the UK was holding a NATO summit aimed at getting others to make a 2% of GDP pledge, David Cameron steadfastly refused to make the same commitment. On several other occasions in Parliament he has also failed to make this pledge.

That being said he did not really need to make the commitment at the time as the UK was still above the required level. It could be a case of simply not making a political commitment that he did not need to make. There are few votes in defence spending and even fewer in pegging its budget to a target the public does not understand. Why back yourself into a future political corner when you don’t have to.

On current spending assumptions, The Royal United Service Institute predicts that the budget will fall to around 1.8% of GDP in the next parliament and may fall as low 1.5% in the one after that. Those figures assume no cuts in SDSR 2015 and the honouring of the government’s commitment to increase the equipment budget by 1% above inflation after 2015. If we do go ahead with a 10% real terms cut then we could drop to 1.6% in the next parliament and 1.4% after 2020.

The UK government has a quite unmatched record of meeting its international obligations. The UK was one of only two countries to meet its Rio Earth Summit greenhouse gas reduction targets and the UK is the only G7 country that actually meets the 0.5% of GDP on foreign aid spending.

There is still a chance that it could become politically untenable for a British Government post 2015 to allow defence spending to fall below 2% of GDP, especially if the USA starts to apply significant pressure.

The budget could be found without raising any additional money by simply reallocating the additional funding given to DFID. This would allow the UK to meet the NATO 2% of GDP target while continuing to meet the pledge given to the G7 of spending 0.5% of GDP on foreign aid.

The second factor that could see budget increases in SDSR 2015 is the country’s finances. In 2010 the budget deficit was predicted to have dropped to zero by 2015. Instead it has been cut by just over half. This is a serious matter because it is beginning to appear that the deficit is structural in nature rather than cyclical.

The latest economic research is now of the opinion that the main reason for the deficit’s existence is  the collapse of income tax revenues. All other taxes are delivering more revenue now than they were pre-recession. Income tax receipts have dropped for a number of reasons but the biggest factors are the low pay of many new jobs, the big reduction in remuneration of very high earners and the tax credits the government gives to low paid workers.

As we have seen in the US economy, this situation could improve relatively quickly. Bonuses can return and more people can start to work overtime.  Another factor that might play out is the cost of debt servicing. The British government is predicted to be spending around £70 billion a year on debt servicing. That is one of the governments largest costs with a budget of double what we spend on defence and around the same as the Department for Education. As inflation has dropped over the past few years so have government bond interest rates. The Government could start to see significant savings on its borrowing costs over the next 5 years. So it may be that in a year or two with no action from the government the deficit will begin to reduce of its own accord.

The third factor that may come into play is the current security situation. This is by far the least important factor of the three when it comes to government decision making but it will certainly help.

The past five years have seen more turmoil in our neck of the woods since perhaps any time post 1945.

The Arab world is on fire along the entire southern shore of Europe. Defence assumptions in 2010 were very much based around the notion that once we were done with Afghanistan we would not be getting involved in another Muslim country. However just a few months later we learned that like Sean Connery, we can “never say never again”. Since 2010 we have become engaged in two military operations in Islamic countries and perilously close to two more in Syria and Mali.

In addition, Russia, the only country that could ever really be considered a material threat to Europe has invaded its neighbour and annexed a fair chunk of its territory. At the same time they continue to not only fight a proxy war for an even bigger chunk of that country but increasingly make provocative moves towards both us and other NATO allies. They have also increased their military spending by around 60% over the same time period.

In SDSR 2010 there was much talk of Europe becoming a strategic backwater with the focus moving towards the Pacific. Europe and the UK were to become “security exporters” only fighting in “discretionary wars”. The “cold war dinosaurs” of fighter aircraft, anti-submarine warfare and armoured divisions were no longer required.

Most of the defence assumptions made in SDSR 2010 were wrong. It would certainly not be difficult for a government in 2015 that had a bit more economic freedom and was in danger of failing to meet a key international target to justify a slight up lift in the MOD’s budget, especially given the current security threats the country faces.

How much

It is open to debate just how much the UK will fall below the 2% threshold on current spending assumptions. No one really knows just how much the UK economy will grow and it’s this growth that is likely to push us below the 2% figure. At the same time we don’t know how much contingency spending there will be on operations.

RUSI puts the figure at 1.8% of GDP which would translate into a short fall of 0.2% of GDP or close to £3 billion a year.

Assuming that the good people of the Royal United Services Institute are probably over stating the amount let’s assume its £2 billion a year. This level of spending certainly won’t revolutionise the UK’s armed forces but it could allow us a chance to fill many of the gaps in our capabilities and enhance our forces in both quantity and quality in a few key areas. These funds could be even more transformational now that the MOD has gotten a fairly good handle on its finances, So the money won’t simply go into the same leaky bucket as before.

Indeed even if the budget is simply maintained at current levels the MOD could have up to an extra £2 billion a year in underspend, unallocated funding and contingency budgets so adding an extra £2 billion on top of that could really make a difference.

In the next parts of this series I will be looking at the few key areas we might spend the money on to generate the best uplift in capabilities that will help to better meet our current security threats.

 

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TAS
TAS
February 7, 2015 8:45 am

Looking forward to the next bit, but do try and avoid the ‘fantasy fleet’ trap.

Very easy to criticise the 2010 review as ‘wrong’, but remember the key focus of that review was rectifying the shocking state of the departmental budget. That will play a significant part in the next review as well – you cannot live on credit forever.

monkey
monkey
February 7, 2015 8:48 am

I think the 2% of GDP will be maintained by other factors also. The US is increasingly leaning on its NATO allies to maintain or increase their spending to the 2% threshold , obviously wanting some of that spent with US companies. The nightmare of sequestration still haunts them , the joys of living in a democracy , and they would like other signatories to pull their weight at least in the long term. Europe however cannot afford it , Spain, Italy, Portugal, France, Greece etc are spending what they can and the newer signatories just don’t have the economies to stretch that far yet. Europe and the US will lean on the UK government to ‘do the right thing’ have a ‘stiff upper lip’ and ‘bite the bullet’ and put our ‘best foot forward and lead the way’ . Several nightmares loom on the distant horizon for Europe within the MENA region in terms of political turmoil , can you imagine the issues if the Muslim Brotherhood re-establishes control of Egypt (and its huge armoury) and turn militant aiding their Brothers in Libya and Syria . At present the West is turning the usual blind eye to how the Egyptian army is maintaining control but the Brotherhood is gaining ground. However unlikely such a shift its one that must be planned for and as one of Europe’s largest economies and one of those seeing signs of growth it will fall on us to keep the British end up.

Chris
Chris
February 7, 2015 10:20 am

Martin – I agree with your three factors and their relative weight in driving the defence budget, but how sad that for those in power the least important factor is the necessity, utility and value in real terms of competent efficient well trained well equipped properly manned armed forces. Especially when the other factors are how embarrassed the politicians can be if the international community see through their weasel words, and the second is how much extra tax they can reap by accident of fate (incurring no bad press for raising taxation criteria).

Funnily enough, should the press make a song & dance of the state of UK defence, the politicians would be clambering over each other to be the first to make random promises of extra defence spending – not that politicians only ever chase the popularist vote – no of course not. Never.

monkey
monkey
February 7, 2015 10:35 am


It would be nice if Germany was to step up but with much of the Greek bailout underwritten by them effectively I would be surprised if the bumped up their spending . Italy is stepping up its Naval procurement but skewing it in favour of its immediate problem of being first in line for the tidal wave of boat people leaving North Africa for Europe’s shores. Greece spends a lot on defence more through paranoia over its neighbours (other NATO members) than commitment to a European goal and do we want Turkey ramping up its spending? France is got the defence political football in its sights after recent events but Spain and Portugal are economic basket cases still. As for the Benelux countries Holland’s at least going to have a squadron of Leopard’s brought out of mothballs so that’s all right :-(

PJS
PJS
February 7, 2015 10:47 am

I have to comment on this notion of 2% of GDP

this is hitching the defence budget to a moving figure [GDP, while accepted as a useful measure by economists and politicians, no doubt – is in itself beset with assumptions and caveats] but lets say we accept this; then when GDP goes up ergo so should spending, if GDP goes down then the assumption must be the total spending goes down, to maintain this 2%.

So how do you plan for future? You might project what GDP will be in 2018/2019/2020/20XX and use this figure – well, if you can do that accurately, Sir, then step up [with your patented crystal ball] and collect your Nobel Prize …

So, MoD plan to buy some nice new shiny things on the hope that a politician will keep his word [cough] in 20XX, and has some bright Oxbridge-type in the Treasury who knows exactly what GDP will be in 20XX [cough], and everything will be hunky dory …

Moreover, if the 2% commitment were to be built into legislation [a la International Aid] and the economy recovers robustly at some near future point, and the maths means there is a bumper return for the defence budget does anyone really expect the government of the day to say, ‘Chaps, you have a windfall go and treat yourself to a few more squadrons and a couple of those big boat things…’

Sorry, I have a Degree in Economics from a very average university but I learnt very quickly that economics has no definite answers …

I am however, deeply saddened about the state of my country, the political class that we have, the commentariat that they pander to, and the dismantling of the one good thing we had left, our armed services.

TAS
TAS
February 7, 2015 11:30 am

Fascinating comments by Fallon that could well have bearing on the review.

http://news.yahoo.com/supplying-weapons-ukraine-escalate-conflict-fallon-153121165.html

monkey
monkey
February 7, 2015 12:35 pm

@TAS
Based on your link and Russia’s nuclear sabre rattling its no wonder we are refurbishing the CBRN Fuch’s . That Russians are updating their nuclear arsenal ,as are we , is a good thing terms of 1970’s era rocketry being driven around various forests by vodka soaked Rocket Force personnel stopping nuclear accidents that could be misconstrued as an attack let alone the any debris from event.

Jeneral28
Jeneral28
February 7, 2015 3:46 pm

http://www.atlanticcouncil.org/blogs/defense-industrialist/is-nato-s-2-of-gdp-a-relevant-target

Is 2% really relevant? Just like the outdated 0.7% aid goal (set in 1970) 2% is an aspired minimum goal but hoe relevant is it to spend 2%?

cky7
cky7
February 7, 2015 7:14 pm

Martin, nice article and looking forward to the next instalment. Re the varying nature of GDP, would it be possible to make future equipment orders of all expendables like missiles etc related to this performance, so for example if GDP performs as predicted we’d order x new Tomahawks but if it under performed we’d buy a few less? Obviously you can’t do the same with manning and major pieces of kit but was trying to think of areas where we’d have a little flexibility as i’m sure GDP projections could be kept reasonably accurate so any difference in actual performance would be small. I guess the major problem is that defence budgets are set so far in advance that predicting your GDP that far ahead becomes much less accurate.
The more i think about it the more i agree that the US are our best hope for keeping defence spending at or above 2% and stopping more damaging cuts. If i were a US taxpayer i’d be mightily pissed off looking at how little europe spends when my country spends the amount they do. Especially when you look at some of the social programs us Euros pump the money into instead and remember that its still really the US that ultimately guarantees our security.
The worlds a very different place to what it used to be and whilst i know they couldn’t threaten to pull out of NATO totally (wouldn’t be in their interest besides all else), i wonder if they could start to threaten/look at removing certain security assurances from nations not puling their weight? After all its supposed to be a mutually beneficial agreement and we (Europe) really ought to be pulling our weight. I’m sure they’ll all want to be covered by the European ABM system after all! Am starting to think anyone wanting us to protect defence spending oughtn’t be talking to our politicians but US ones instead!

Obsvr
Obsvr
February 8, 2015 2:54 am

The great strategic question of the age is whether or not ISIS aspire to export their beliefs beyond SW Asia and N Africa. It seems to be Yes for some areas (eg Western China – which should keep the PLA busy for a while). I also think it likely that Turkey will be unable to resist them – ISIS beliefs resonate with the faithful. It’s interesting that in Iraq all the former Baathists are happily signing up in the North. Iran is looking a better potential ally by the day. There seems little doubt that a significant chunk of the world is heading for radical changes, with an as yet very uncertain impact on W Europe.

One question is whether or not ISIS can resurrect a nuclear weapons program, possibly with Pakistani help.

Gloomy Northern Boy
Gloomy Northern Boy
February 8, 2015 11:09 am

“Whether or not ISIS intend to export their beliefs”…The Qu’ran can be read in a number of ways, but the most rigorous position is that the duty of good Muslims is to make the whole world “Halal” (permissible) by ensuring that everybody in it has come to “Islam” (submission)…a more moderate position might be that everywhere that has ever been “Halal” must always remain in that happy state (Which means the Balkans, Sicily and Southern Italy and Spain in our direction…India and many points further East in the other). The question for me is not the intention but the capacity, on which makes a fair point but might in my view be a little sanguine. Let us recall that when the aspiration to a unified Ummah led by a universal Caliph was raised even on this site a couple of years ago, the general reaction was that they were talking tripe…

What I recall is that the first iteration of AQ was as a pretty standard terrorist organisation opposed to the US presence in The Kingdom (where they still exist)…next came a stint as the honoured guests of a friendly regime out of which came 9/11(where they still exist)…and now, albeit under different leadership territorial conquests by both Daesh and Boko Haram (where they are still growing)…my money is on a Shura, Diwan or some such to work out the terms for consolidation sometime this year or the next. Let us bear in mind that the model they aspire to is one based on the warlords and tribal chiefs of the seventh century, not anything that resembles a modern state…extensive use of modern media notwithstanding.

GNB

Chris
Chris
February 8, 2015 11:56 am

Gloomy – certainly in the near term I fear for Turkey; they are bit by bit dropping the secular westernised position that was the result of Kemal Atatürk’s reforms, moving their society closer to those south of their borders. Its a great shame in my opinion; until maybe 10 years ago they were a shining example of how well an Islamic state could fit into the modern world almost seamlessly and as a respected equal, as no doubt was the intent of Atatürk in the first place.

As for the alignment and pooling of resources between the murderous Islamic factions, the only bar to this would be if their various leaders fought for the rights to be top dog.

So, with a belligerent Russia feeling the stern gaze of NATO and felling a bit threatened by it, and two sides of the Mediterranean under threat from the most xenophobic tribe of murderous thugs in living history, and a significant minority of UK citizens having a somewhat ambiguous view of loyalty split between nation and religion, and the US attention swinging towards the Pacific, and many of the EU and NATO states reducing their defence capability on the basis ‘someone else will help if needed’, of course SDSR15 will significantly bolster the UK’s defence capability – anything less would be failing at the first duty of Government, which is to protect the country and its citizens. Wouldn’t it?

Nick
Nick
February 8, 2015 12:44 pm

Martin

2 % of GDP might not be the ideal measure, but if you live in the real world with inflation (and was defence equipment inflation of greater than “real” world inflation) maintaining a target of 2 % of GDP does at least inflation proof the budget from a national wealth point of view.

This is more of a political comparison target anyway; The idea is to make sure that all NATO members spend broadly at the similar level relative to the size and wealth of their economics.

Whether the next UK government maintains the 2 % commitment will largely be a UK political ideology decision. If your political aim is to have small government and free market provision of welfare, pensions and healthcare then defence will have to share the burden of an across the Board cut-back if you consider that the only way to eliminate what you correctly call a structural deficit. However, if you believe there is an alternative route (reducing low pay by wealth redistribution) then its less likely in my opinion.

The “real” longer term solution (rebalancing the economy away from consumption to export with a higher added value service and manufacturing component) has been on the table for at least 40 years with very little progress on delivering it (probably because no one really knows how to do it).

Nick
Nick
February 8, 2015 12:47 pm

Chris

wouldn’t your increased spend re IS go to the police and security services for internal UK security and on Trident replacement re Russia.

Gloomy Northern Boy
Gloomy Northern Boy
February 8, 2015 1:36 pm

– of course it would :-) but it won’t :-( …

Warming to the broader theme, we have grown accustomed to the corporate state which enjoys a monopoly on lawful violence; but that only came into existence during the Reformation and the religious wars that accompanied it (finally being established as the norm for international relations at the Peace of Westphalia in 1648)…prior to that every great City had places like Petty France or Steelyard, where other communities lived according to their own laws and customs.

However, that model never took such deep roots in the Islamic World…hence the continued importance of family, clan and tribe…the ability to raise lawfully armed militias at the drop of a hat…and indeed the continued existence of communities like the Assyrian Christians and Yazidis who on the face of it seem to be in but somehow apart from the State in which they live…similarly the Copts in Egypt and no doubt others elsewhere.

That being so, a self-selecting Caliphate without contiguous territory, but comprising some safe havens (Yemen, the Tribal Territories, the Daesh and Boko Haram areas) linked together by the illicit use of international air transport, a strong “dark network” presence, some collective planning around how and where to smite the infidel, and a very strong e-propaganda presence seems to me a very satisfactory way to advance the Black Banners of the Faithful without attracting a full scale Western response…until the next and probably more dangerous iteration…

…furthermore, it is also an excellent organisational framework within which to exploit the ambiguity which some communities in the West clearly feel towards the states where they are located, but don’t exactly seem to live. When, for example would we act against the London Borough of Tower Hamlets in a serious way…when the Council declare themselves hypothetically in favour of Sharia Law? When the odd non-Muslim member of departed staff takes them to a tribunal instead of quietly moving on somewhere more congenial? When the odd non-Muslim business remonstrates about planning powers exercised on the assumption that the “community standard” is haram or halal? When the Women’s Refuge Movement starts very uncomfortably reporting on numbers of Bangladeshi Women and Girls fleeing from the imposition of “community standards” which have no place in London in 2015? When the Metropolitan Police start shifting uneasily in their chairs if asked about “community standards” in Justice resulting in a diminishing need for an official and lawful police presence? When the first rumour of a known petty thief losing his hand in an “industrial accident” pops up here or there? When the first sassy Bangla Chick is found on waste ground, apparently beaten to death with quite a large number of rocks?

In fact, if there is anyone out there closer to Tower Hamlets than I, I’d be interested in their reaction to my list… :-)

A curious Gloomy

mickp
mickp
February 8, 2015 1:51 pm

@Nick – police and security services yes, but hopefully that doesn’t all come out of the MOD budget. I would like to see coast guard and border force being combined into an effective border security and patrol force with fixed wing air (C295 type) again possibly not all MOD budget. Successor 4 boat replacement is a no brainer for me in terms of the boats.

The real big ticket kit missing is MPA. We’ve debated at length but the easiest option is a at least a dozen P8s and the 737 becomes a future replacement for a range of aircraft.

I would also like the army restructured again to create a 2nd reaction division at a medium weight level and the RAF structure needs looking at in terms of fast jets to keep at least 8 squadrons plus F35B (no more than 3 squadrons of those) – so T1 Typhoon, Tornado OSD push, Griipens possibly or more T3 Typhoons whichever is the most cost effective. We should have a longer range bomber force (or payload delivery system) in my view. One for the future though

For the RN, keep the B2 Rivers, a commitment to 13 T26s and a couple of extra Astutes please

Other than that the key is to keep what we have and fill smaller gaps in kit and manpower and to keep current kit relevant.

Allan
Allan
February 8, 2015 10:00 pm

“The “real” longer term solution (rebalancing the economy away from consumption to export with a higher added value service and manufacturing component) has been on the table for at least 40 years with very little progress on delivering it (probably because no one really knows how to do it).”

Because in a globalised world it is pretty much impossible – the Germans kept manufacturing going and slowly ‘wound down’ steel and coal and the like. HMG decided that it wanted the UK to be a ‘service island’ and pretty much gave up on keeping manufacturing going in one go.

The rise of the BRIC economies – much cheaper wages etc. – will continue to hammer UK manufacturers unless protectionist measures are taken. If HMG doesn’t want a large chunk of people working making stuff then there will be no change in policy.

Nick
Nick
February 9, 2015 11:10 am

Allan

Whilst you’re right of course, you can take examples (eg car manufacturing, pharmaceuticals) or services (eg film industry) where skilled UK work force is able to compete very well on the international stage. What we lack is a this sort of presence in a wider range on industry sectors than presently. This is possible, but requires dedicated financial (venture capital funding), infrastructure and skills training etc.

What we certainly can’t do is to try and compete at the low cost, low skill screw driver assembly level. Unfortunately most employment growth in the current period recover is low paid, low skilled part time and self employed jobs. Whilst many self employed jobs created may eventually grow into a stronger entrepreneurial sector right now it isn’t really helping that much.

Chris
Chris
February 9, 2015 12:36 pm

Allan, Nick – ref Germany vs. UK – worth remembering at the end of WW2 Germany was broken; its rebuilding from scratch was funded by the Allies (mostly the US but big contributions from others) and as it was starting from new it built new facilities with new machinery within and created workforce structures that suited the need to get on with rebuilding New Germany. On the other hand, the UK had not quite been broken but its industries were exhausted shadows of their pre-war state, the machinery was old and worn out, and far from gaining aid from our allies not only did we pay into the Germany rebuild pot, but we paid the US at least in part for their assistance (I think our last payment was 2006?). We also as part of the Lend-Lease arrangements sent a large volume of technological data on British inventions & research to the US, significantly damaging the nation’s future manufacturing advantage, but at the time it was necessary and sensible. So where Germany was building shiny new modern facilities with a grateful workforce, the UK was in make do & mend mode, with a dischuffed workforce that expected to reap benefit from the sacrifices of fighting and winning a war but instead were either in much the same positions as before the war, or finding employment very hard to come by. The bosses needed the workforce to crack on and make stuff so they had cash to reinvest; the workforce needed new or at least functioning machinery on which stuff could be made; the bosses thought the workforce were not trying hard enough; the workforce thought the bosses were unreasonable; strife in the workplace escalated (in some cases encouraged by those of extreme left-wing tendencies hoping the factory arguments might erupt into full-blown workers’ revolution); potential investors looked on and saw no prospect of any return on investment in these strike-ridden organisations. The spiral down into irreconcilable differences continued into the 80s by which time UK industry was a laughing stock around the world; a position unthinkable before the war.

Even now, with the three big Japanese car plants on UK soil making huge numbers of cars as well as any other factory could, and Jaguar Land Rover under Tata’s ownership looking strong, and JCB’s little yellow diggers still being the standard by which others are measured, and high-tech innovations wowing the world, still this country is not held with the regard of Germany when it comes to engineering. You might ask what industry has to do to fix the reputation?

On the contrary, I ask what the Government has to do to fix the reputation. For example why are new trains for the nation’s railways being built in Japan? Why are future nuclear power stations gifted to a French/Japanese group? On the defence side, why do we buy aircraft from the US and tankettes from Spain and lorries from Germany? If you were a nation state elsewhere in the world and were looking to buy valuable equipment on behalf of your taxpayer, you would instantly dismiss any offering from a UK bidder if even their own government thought it was worse than an imported option. Unless the government shows that UK products are as good or better than those from other states by actually buying them, how on earth can it expect other nations’ governments to buy British and not the foreign competitor’s kit that the UK government bought?

Much then of the nation’s difficulty in grabbing export share falls on the shoulders of a weak and backside-covering elite in Westminster who absolve themselves from blame by pointing at everyone else and stating its up to their prime contractors’ business imperative, cheapest bidder wins, open market rules etc. So long as no blame ever gets back to Westminster the country can be taken to the cleaners.

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