The case against spending targets
15 May 2019
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Tax and Fiscal Policy
19 November 2024
For politicians, there is something attractively simple about spending targets. Rather than argue the nuances of why the Government of the day feels it needs to x, y or z – boiling it down to how much they’re aiming to spend on each is much easier to explain. The 0.7% of GDP target for foreign aid, for example, is widely known and understood. The policy followed years of campaigning by anti-poverty charities, notably the Jubilee campaign, and attracted widespread support. This week, the Foreign Secretary has suggested that defence spending should rise from a 2% of GDP NATO target, to nearer 4% in line with spending by the USA.
Who could dispute either? The former invokes images of the UK doing good across the world, underpinned by a sustainable source of funding that grows or shrinks only in line with ‘what we can afford’. The latter shows our commitment to domestic and global security. Both of those are valid aspirations, either of which could be presumably better achieved with more resources? But they may not.
The problems are these:
The aid target is a great case study on all of these. Sending money to areas of the world in need is not difficult. Ensuring it ends up supporting those needs, rather than lining the pockets of dubious regimes, crowding out domestic investment, or creating dependency, is extremely difficult. When the aid target was imposed the Department for International Development it found it difficult to find new projects that met their not unreasonably high standards. They did not hit the target, but with good reason: they didn’t want to spend it unwisely. Begging the question that if the goal of the policy was to increase funding of good quality projects that deserved funding, what was the point of the target?
This is equally true of defence spending. Semi-regular Strategic Defence and Spending Reviews always start with threat assessments, current and future. How to manage those threats comes next, followed by what could be spent, finally what will be spent. The target is irrelevant to both the assessment and final decisions. And so it should be; at time of war for example, the figure could be as high as 50%; in the lull of a long peace well below 1%. A target in that context is meaningless.
Then there are unintended consequences. Rapidly increasing spending on anything tends to cause cost inflation as supply fails to keep up with demand. The UK cannot recruit soldiers or aid workers on magic jobs plantations, it takes time to recruit, train and enable people. Capital equipment and technology does not materialise instantly, particularly not in a military context, it requires time and investment to deliver economies of scale and experience to ensure value for money. Flooding the market with money for future tech, when that tech is at its most expensive, is guaranteed to come with a high degree of waste, something very familiar to those involved in defence procurement.
Ah yes say some, but what about global leadership, if we do x, others will also do x, and more good / stability and peace will follow. This is a dubious argument unsupported by evidence. Self-evidently US military ‘leadership’ for decades has not led to Europe following suit, or neither the US nor UK would be concerned about it. Conversely it has encouraged free riding, as we might expect given the political attractions of diverting domestic resources to higher domestic priorities, the US having generously donated their treasure to keeping allies secure. Appeals to British ‘leadership’ on tackling climate change (for which read overspending on imported obsolescence), or global spending targets for climate mitigation should be treated with equal scepticism on this basis. And then there’s the clear point that if spending targets encourage waste in one country, globalised spending targets merely amplify that issue worldwide.
In short, there is nothing to suggest spending targets have value beyond their appeal as a sales pitch for interest groups. In regards to the public finances, they undermine prudence, creating incentives to splurge. In regards to international co-operation, they encourage complacency, creating incentives to free ride. All of which, long term, builds up to a very unattractive alternative to limited Government, living within its means, only spending where no better alternative exists, in response to clearly identified needs.
Who could dispute either? The former invokes images of the UK doing good across the world, underpinned by a sustainable source of funding that grows or shrinks only in line with ‘what we can afford’. The latter shows our commitment to domestic and global security. Both of those are valid aspirations, either of which could be presumably better achieved with more resources? But they may not.
The problems are these:
- what to spend should be driven by need,
- quantity of spending does not equal quality, and
- spending can have unintended consequences.
The aid target is a great case study on all of these. Sending money to areas of the world in need is not difficult. Ensuring it ends up supporting those needs, rather than lining the pockets of dubious regimes, crowding out domestic investment, or creating dependency, is extremely difficult. When the aid target was imposed the Department for International Development it found it difficult to find new projects that met their not unreasonably high standards. They did not hit the target, but with good reason: they didn’t want to spend it unwisely. Begging the question that if the goal of the policy was to increase funding of good quality projects that deserved funding, what was the point of the target?
This is equally true of defence spending. Semi-regular Strategic Defence and Spending Reviews always start with threat assessments, current and future. How to manage those threats comes next, followed by what could be spent, finally what will be spent. The target is irrelevant to both the assessment and final decisions. And so it should be; at time of war for example, the figure could be as high as 50%; in the lull of a long peace well below 1%. A target in that context is meaningless.
Then there are unintended consequences. Rapidly increasing spending on anything tends to cause cost inflation as supply fails to keep up with demand. The UK cannot recruit soldiers or aid workers on magic jobs plantations, it takes time to recruit, train and enable people. Capital equipment and technology does not materialise instantly, particularly not in a military context, it requires time and investment to deliver economies of scale and experience to ensure value for money. Flooding the market with money for future tech, when that tech is at its most expensive, is guaranteed to come with a high degree of waste, something very familiar to those involved in defence procurement.
Ah yes say some, but what about global leadership, if we do x, others will also do x, and more good / stability and peace will follow. This is a dubious argument unsupported by evidence. Self-evidently US military ‘leadership’ for decades has not led to Europe following suit, or neither the US nor UK would be concerned about it. Conversely it has encouraged free riding, as we might expect given the political attractions of diverting domestic resources to higher domestic priorities, the US having generously donated their treasure to keeping allies secure. Appeals to British ‘leadership’ on tackling climate change (for which read overspending on imported obsolescence), or global spending targets for climate mitigation should be treated with equal scepticism on this basis. And then there’s the clear point that if spending targets encourage waste in one country, globalised spending targets merely amplify that issue worldwide.
In short, there is nothing to suggest spending targets have value beyond their appeal as a sales pitch for interest groups. In regards to the public finances, they undermine prudence, creating incentives to splurge. In regards to international co-operation, they encourage complacency, creating incentives to free ride. All of which, long term, builds up to a very unattractive alternative to limited Government, living within its means, only spending where no better alternative exists, in response to clearly identified needs.
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As Brexit Day approaches, there will be a further squeeze on public finances and it will be increasingly difficult for the government to fulfil its 2% spending target on defence.
It is a good idea to follow the money of this spending, because it reveals that British capitalism – in its increasingly cronyist guise – is doing the public a disservice. The defence industry is an example of a publicly-funded sector that expects to be subsidised in perpetuity. It also suffers from the increasing problem of concentration of economic power made worse by ill-considered policies of previous governments, including that of Tony Blair.
The dominance of just a handful of manufacturers, the Select Few, has been a distinctive feature of the defence equipment market for as long as anyone can remember.
Unlike the market in consumer goods and services, there is only one customer for defence equipment – the government. Consequently, the purchasing decisions taken by the government has a significant bearing upon the composition and diversity of players in the defence equipment market. And because taxpayers money is used by the government to procure military equipment for the Armed Forces, the condition of the defence equipment market should be of concern to anyone who has an interest in the proper functioning of open and free markets, and in securing best value for money, as it relates to the expenditure of public funds.
Nowhere is the market in defence goods more concentrated than in the naval shipbuilding sector, as exemplified by the number of bidders who entered the competition to build the Type 31e general purpose frigates for the Royal Navy. It is the first time that a contract for combat ships has been competed openly on the global market, to identify the bidder that will construct the five Type 31e frigates. Hitherto, the contractor to receive such a single-source design and build contract has always been selected on a preferential basis (from the Select Few) – by successive generations of people in the pay of the State who have a poor understanding of how free markets work, not least, because they have not spent a single day of their lives in the private sector.
The consequence of this misguided attempt at shaping the shipbuilding industry has been an unmitigated disaster. Only three industry teams have responded to the (second) announcement to submit expressions of interest for consideration by the procuring authority, the Ministry of Defence – this, after the government went out of its way to relax the demanding technical specification requirements incorporating stringent naval standards, specifically to attract commercial shipyards. A minimum of seven bidders are required to run the winner-takes-all competition efficiently. See this illustration pic.twitter.com/RUToAZ6thx.
It may be that foreign companies do not believe the government’s word when it says that it will run a genuinely fair competition open to all-comers, including offshore yards – only to then surreptitiously favour domestic contractors, as has happened so often in the past.
For an island nation with a long tradition in naval shipbuilding going back centuries, such an outcome is a huge disappointment and it leads one to conclude that there is a serious lack of competitiveness in the naval shipbuilding sector. It is the number of bidders entering a competition that determines how competitive a product market is – the higher the count, the healthier and more vibrant the market, and the keener the desire on the part of contestants to win the contract.
This dire situation has come about because successive governments, going back decades, have sought to protect domestic equipment manufacturers from being exposed to the full rigours of the free market, that is to say, shield them from ‘feeling the heat’ of competitive market forces – which has, in itself, led to this market concentration.
The creation of the monolithic entity called BAE Systems which dominates the defence equipment market today – from the acquisition of various business units of Marconi Electronic Systems in 1999 with the tacit acquiescence of the Blair government, without referring the merger to the then Competition Commission – further reduced the number of independent participants in the market.
BAE Systems then went on to use this dominant market position to stifle competition and coerce the Brown government into signing a 15-year Terms of Business Agreement* in secret which, in effect, hands out a series of cost-plus, naval shipbuilding contracts worth £3,450 million up to 2024. In so doing, future governments have been denied freedom of manoeuvre in the management of public finances.
What’s more, in common with concentration of economic power elsewhere in the UK economy, the defence equipment market monopolised by the usual suspects is plagued by excessive mark-ups, insignificant investment in innovation, R&D and product development and persistently low wages for the vast majority of its workers.
@JagPatel3
* Fully examined in written submission to the Public Accounts Committee, Inquiry into Defence Equipment Plan 2017-27, HC 880, Session 2017-19, Written evidence from Jag Patel, published 13 March 2018, PDF file (294 kB): http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/public-accounts-committee/defence-equipment-plan-201727/written/79612.pdf