Economic Theory

Why are taxpayers being forced to bail out billion-pound defence contractors?


There are 680 very happy steel workers in Sheffield right now. The nationalisation of Sheffield Forgemasters, with the promise of £400m of public investment, should secure their jobs for at least a decade. This is a win for them and their labour unions. Behind the scenes there are other winners. The current underwriters of Forgemasters are three defence contractors, BAE Systems, Rolls Royce and Babcock International. They acted as guarantors for bank loans to Forgemasters of £30m in 2017, although the figure has risen to £40m in the 2019 accounts. It seems likely that these partners, who are also Forgemasters main customers, were not prepared to continue or extend the arrangement, risking liquidation, without a new angel investor. The Government, or rather, you, the taxpayer, is that angel.

The reason offered is that Forgemasters are a crucial part of strategic defence supply chains, notably Britain’s fleet of nuclear submarines and cannot be replaced at short notice. This has some merit, jeopardising or delaying multi-billion deals vital to national security to avoid spending a few million now makes little sense. But this is an argument for very temporary state ownership, much as was proposed for the East Coast mainline in 2018 (just 2 years), not a ten-year investment plan. Fundamentally the business is either viable or it is not. Fundamentally, it can either be made viable by investment or it cannot. That no private sector operator was prepared to step in, including those who know it best and have the resources to do so, is clearly not a vote of confidence. That the Government think 10 years of investment is necessary before even thinking about privatisation is not either.

A second reason offered is the need to invest in domestic supply chains. This is a terrible argument, albeit good politics. Long-term however it helps no one to pretend that an industry accounting for less than 0.1% of GDP and 1.2% of manufacturing, in which we are net importers of product, is ‘too strategic to fail’. We’ve seen this before with Steel. In the 1970s nationalisation was used to protect jobs at the expense of everyone else, while it did nothing to stave off global competition. When privatised in 1988, dozens of zombie firms with no serious business model vanished. The UK used to be one of the world’s largest producers of steel. It has not dropped to a rounding error below Malaysia and Saudi Arabia in 24th place through failure, but the comparative success of other domestic industries, and comparative advantage in commodity manufacturing elsewhere. The main factor costs of production for steel are energy, raw material, plant and people. None of these things are relatively cheap in Britain, and it is a matter of national strategy to make nearly all of them more expensive in the longer term.

For example net zero is a plan for more expensive energy, much of it unsuitable for energy-intensive industry. Levelling Up is a plan to make labour more expensive, particularly in the manufacturing heartlands of Britain. The Government has consistently failed to remove plant and machinery from business rates. It has failed to free up more land with planning consents for manufacturing sites. It has failed to reduce the ability of locals to stop them being built. All of which make investment in factories here very unattractive. Raw materials are global commodities, and the UK is rather better at creating complex financial instruments for hedging that risk than at finding new sources or more efficient methods of extraction. You cannot even suggest opening a coal mine for coking steel in Britain these days without multiple NGOs proclaiming you hate the planet.

Oddly, the Government think their energy strategy may help save Forgemasters. They have some involvement in Rolls Royce’s prototype plans for small scale nuclear, they have the giant forges required to produce components for conventional nuclear. Their steel can be found in wind turbines and no doubt some of the support structures for various solar arrays. But these are not areas in which they can sustain comparative advantage. The ‘Green Growth Paradox’ is that the measures designed to incentivise demand for low carbon energy (general supply subsidies or carbon taxes) make the production of materials for those energy forms unaffordable. The net impact of three decades of planning for the low carbon transition has been to accelerate the offshoring of any industry with high energy needs. This will not change.

Nor is the Ministry of Defence an obvious partner for those who believe that the solution is just a better investment plan. British defence procurement has been widely and repeatedly criticised as wasteful and incompetent. It is not just the usual complaint that civil servants would not know a forge from a foundry, let alone understand how to grow a global export business, but that the top brass gold-plate everything. 40,000 tonne aircraft carriers become 70,000 tonne monsters, running years over time and budget, because size matters when you are floating next to the US Navy in a squall. Tanks do not work. Really interesting innovative ideas get retrofitted to unsuitable prototypes, and become unusable. And so it goes on. Sometimes it is better to buy anything but British and have guns that actually fire when it is hot or cold.

Now the armchair generals have a giant hammer to play with, and a mission to prepare the North for occupation by Conservatives, one would have to have a head of steel to believe that they will do anything other than meddle. Government investment might save Forgemasters as a viable business long-term. But if so, it will be more likely by accident than design. The losers in all this are you the taxpayer. The bill for this bailout will need to be paid. That in turn means higher taxes, which in turn means job losses and lower wages across the wider economy. It is only if you sincerely believe that the MOD has been transformed from Dad’s Accountants to the SAS of venture capitalism, that this will not happen. Meanwhile the question remains. Whatever we think about Forgemasters themselves, why are we bailing out the multi-billion-pound defence contractors who bet on them, and lost their bet?

 

Andy Mayer is Chief Operating Officer at the IEA. Andy worked as Head of Public Affairs, UK & Ireland at BASF plc for seven years. He has over 20 years of experience in strategic communications and the operations that support them in the business and think tank worlds.


1 thought on “Why are taxpayers being forced to bail out billion-pound defence contractors?”

  1. Posted 03/08/2021 at 09:16 | Permalink

    The centre of government seems to have learnt lessons from MoD’s disastrous handling of defence procurement programmes over the last several decades. It is, as you say, buying anything except that which has been designed and manufactured in-country – and this is not only because of the appallingly poor performance exhibited by indigenous defence contractors.

    It is increasingly moving away its longstanding policy of procuring equipment designed to a bespoke technical specification requirement because it is no longer confident in the ability of its own people at MoD Abbey Wood to identify, manage and control technical risks inherent in a starting-point for the technical solution that requires development work to be performed upon it – which has been the cause of persistent delays and cost overruns on equipment procurement programmes for as long as anyone can remember.

    Whereas the government has not come out and said so publicly, it has quietly revised its defence procurement policy to consider buying, as its first and foremost priority, new military equipment for the Armed Forces which automatically falls in the off-the-shelf category – specifically, because an off-the-shelf equipment is a fully engineered and supported technical solution which satisfies the key user requirements at no additional cost or risk to the Exchequer, that is to say, it does not require any UK-specific modifications or related development work laden with risk to be performed upon it.

    In so doing, this government has put financial security and the national interest first, not domestic equipment manufacturers’ commercial interests.

    The severe financial crisis at MoD has forced it to adopt a zero-tolerance attitude towards persistent delays and cost overruns on defence procurement programmes which has, in turn, seen it go for off-the-shelf purchases to satisfy its military equipment needs – in the shape of orders for the P-8A Poseidon maritime patrol aircraft, Apache AH-64E attack helicopters, MQ-9B Protector armed drones, E-7 Wedgetail airborne early warning and control aircraft, BOXER armoured vehicles and now H-47(ER) Chinook heavy-lift helicopters whilst the Joint Light Tactical Vehicle has been identified for its Multi Role Vehicle–Protected (MRV-P) requirement – the last four, after having first conducted a comprehensive market survey and then a comparative analysis of existing, in-service platforms. All of this equipment is being sourced from manufacturers of foreign origin.

    To its credit, the government has realised that the most important benefit to be derived from buying off-the-shelf equipment via a government-to-government deal is that it allows any hidden technical, financial and schedule risks – which have dogged the so-called, minimal development solutions proposed by domestic equipment manufacturers – to be transferred to the other government. This is especially pertinent given that domestic contractors are unable to tackle such risks because they no longer possess an in-house design & development capability, and haven’t done so for many years.

    Additionally, it will not be necessary to maintain the usual (overmanned) procurement team, when a skeletal procurement team can easily see each acquisition through – which paves the way for the government to reduce the headcount at MoD’s procurement organisation in Bristol even further, in numbers not possible before.

    After being misled by UK-based defence equipment manufacturers with false promises and lies for decades, this generation of elite politicians, senior civil servants, military top brass and front-line procurement officials have been so badly scarred that, there remains little appetite to consider any alternatives that may be put forward by these same dishonest suppliers.

    This tragic situation has come about because it does not possess the capability in the form of intelligent and experienced procurement officials who have an adequate understanding of what it takes (in terms of skill types, funding, tools, processes, materials, scheduled work plan, inter-business contractual agreements etc.) to advance an immature technical solution from its existing condition, to a point where it will satisfy the technical specification requirement, within a private sector setting driven by the profit motive and people who instinctively employ sharp business practices. Consequently, they are not able to establish what the true status of the evolving technical solution is, based upon claims made by contractors. The harsh truth is that, these people have no business acumen at all – on account of not having spent a single day of their lives in the private sector and yet, they have been put in charge of spending taxpayers’ money to the tune of £17bn per year to buy defence equipment, outsourced services and labour from the private sector.

    Nor is the existing defence procurement process (which has evolved over the years) conducive towards delivering equipment to the Armed Forces which is fit for purpose, adequately sustained in-service and constitutes value for money through-life, because it has been tampered with by defence contractors (most notably the Select Few) who have skewed it decisively in their favour, at every turn.

    The government’s considered assessment is that it is unlikely to accumulate an in-house capability of the desired quality and numbers anytime soon, certainly not in the foreseeable future. It has also been realistic and concluded that it is nigh on impossible to reconstitute the existing, flawed procurement process alongside past Spending Review efficiency savings commitments further complicated by Brexit and now the Covid-19 pandemic, the effort on which has commandeered the brightest people in Whitehall and made the task of balancing the MoD’s budget even more difficult – hence its preference for the off-the-shelf option.

    Ironically, one of the most spectacular benefits to be derived from buying off-the-shelf equipment is that the administrative leadership at MoD will be absolved from its burdensome responsibility of having to upskill its existing procurement staff to a level comparable with that exhibited by counterparts in industry, because this type of acquisition is relatively straightforward, and can even be undertaken by mediocre post holders with no business sense – not least, because it is devoid of any hidden financial, technical or schedule risks which are inescapable features of development programmes.

    It is believed that a quarter of the UK’s equipment procurement budget is currently being spent on buying off-the-shelf equipment. This slice is only set to increase during the remainder of this Parliament, as more and more projects which involve significant development work are side-lined in favour of off-the-shelf purchases.
    @JagPatel3

Leave a Reply

Your email address will not be published.


SIGN UP FOR IEA EMAILS