JON STANFORD. Business welfare under the Coalition: two case studies (2)

This is the second of two articles by Jon Stanford on the Coalition’s approach to industry protection and ‘business welfare’. Part 1 (Motor Cars) can be found at Jon Stanford. Business welfare under the Coalition: two case studies.

Naval shipbuilding

At the outset, we need to understand that there are no significant defence reasons for building naval platforms in Australia. Self-reliance means that Australia must be capable of maintaining its defence platforms and systems to a high standard and returning damaged assets to full availability as quickly as possible. Australia does not produce a single missile or weapons system that is employed on its ships, not even a 5-inch gun. Apart from the excellent CEA Technologies naval radars, almost every defence system in the ADF comes from overseas. We do not build any fixed wing platforms for the RAAF, nor do we make the Abrams tank. A sensible acquisition policy should focus on value for money, with local procurement only occurring when it represents an efficient use of resources.

Initially, the Abbott government took a rational approach to naval shipbuilding. In order to save money and obviate the need to upgrade the Collins class, Tony Abbott sought to buy Soryu class submarines off the shelf from Japan. The government was critical of shipbuilder ASC (remember the “canoe”) and stated that future warships would only be built in Australia if productivity increased significantly.

Two years later and this approach has been overturned. The Turnbull government proposes to acquire twelve submarines of French design (DCNS), to be constructed in Adelaide at a cost of $56 billion. At $4.6 billion per boat, this is an eye-watering price for a conventional submarine. By comparison, India is acquiring six French submarines, admittedly of a smaller size, for a total of around $4 billion. A Virginia class nuclear submarine, twice the size and far more capable, currently costs $3.6 billion in the US.

Apart from its unacceptable cost, the DCNS proposal involves substantial risks. The delivery schedule is so tardy that the Collins submarines will need major upgrades, at a probable cost of at least $15 billion, so as to remain in service well into the 2040s. This gives rise to safety concerns. Uniquely, the French proposal involves converting a submarine designed for nuclear propulsion to diesel-electric. Apart from inducing much mirth on the part of submarine experts worldwide, this involves substantial technical risks. Piers Ackerman quotes a senior Defence official as saying “If you asked someone to devise a new submarine program with the highest risk factors at every stage, you could not have done a much better job. It will almost certainly end in tears and possibly a catastrophe”.

In this process, Defence rejected a very attractive $20 billion proposal from TKMS, a German company with submarine technologies that dominate the global export market. TKMS guaranteed the cost of building 12 submarines in Adelaide would be no higher than in Germany and offered a fixed price contract with early delivery to obviate the need for a costly upgrade of the Collins class. The proposal also involved a wholesale transfer of digital technology from Germany and the strong possibility of Australian industry involvement in a global supply chain. The reasons for rejecting the TKMS proposal have yet to be adequately explained.

Car manufacturing, the imminent loss of which may cost an estimated 200,000 jobs, has an effective rate of assistance (ERA) of less than eight per cent. The proposed submarine acquisition will require an ERA in excess of 300 per cent. In return, according to the Defence Minister, the project will create “1,100 jobs in the shipbuilding process, potentially 750 jobs in the supply chain”. As a pay-off for such a high ERA, this is a very damp squib. At a cost of nearly $400,000, Defence commissioned a report on the economic impact of the submarine project but has elected not to release it.

Following this extraordinary decision on submarines, we may well inquire of the government: “What do you do for an encore?” All this, and more. The next step is to provide open-ended protection to building surface warships. In doing so, the government has overturned the approach laid down in the Defence Industry Policy Statement (DIPS) that accompanied its own White Paper. Under the DIPS, acquisition policy would “seek to achieve the best value for money” while giving consideration to “opportunities to maximise internationally competitive Australian industry involvement” [my italics].

That was in February. Speaking in Adelaide in April, the Prime Minister said “I am determined that every dollar we spend on defence procurement as far as possible should be spent in Australia”. Seemingly regardless of cost, risk and delivery, major warships will in future be consolidated by a monopoly shipyard in South Australia. Further, the so-called ‘valley of death’, the peaks and troughs in demand that are the bane of the naval shipbuilder’s life, will be eliminated by having a rolling build program. This means that in order to maintain a continuous workload, modern naval assets will be replaced well before the end of their effective lives. This must be the ultimate example of the tail wagging the dog.

The ERA for this policy has yet to be calculated but could run to the hundreds of per cent. As the Australian Strategic Policy Institute (ASPI) suggests, “mindful of what the Prime Minister said in Adelaide, future defence contractors will be packing in as much local content as they can, with the risks borne by the ADF and the costs by taxpayers”.

Why did policy change so radically after the White Paper was published? One need not be a cynic to suggest that the only thing that changed between February and April was that an election started to loom large, with a couple of seats in South Australia in the balance. When the consequences of this policy change eventually become apparent, some researcher will be able to calculate the cost to the taxpayer, if not the benefit, of keeping Christopher Pyne in parliament.

It is not as if the government is building this new policy on the back of a productive and efficient naval shipbuilding industry. ASC in Adelaide has been consolidating three air warfare destroyers (AWDs) for the last ten years. They have been plagued with cost and delivery overruns. Finance Minister Mathias Cormann has noted that “these ships are costing $3 billion a ship when equivalent ships from other parts of the world would have cost us $1 billion a ship”. Not only is the cost of the ships unacceptable, but they are already years late in delivery, leading to significant additional costs for the RAN. Moreover ASPI warns that now the more straightforward shipbuilding tasks for the AWDs have been undertaken, we should watch this space. “On past experience, the hard parts are yet to come.”

This is bad enough but worse is to follow. The White Paper included a planned investment of up to $5 billion for combat system upgrades for the AWDs. While no detail was provided, ASPI has reverse engineered this and concluded that the original Aegis systems (which were acquired years ago) are now out of date. So on completion, the AWDs will need to undergo a major and costly refit. An innovative solution to the valley of death problem, therefore, is to spend so long building ships that they are obsolescent when completed. They can then move seamlessly into their mid-life upgrade with no blip in the workload.

Surely this is enough? But no, there’s even more. Some of the upgrades to Aegis that the Navy requires will be difficult or impossible to integrate on the relatively small platform that Defence selected for the AWDs. Looking at the last two ships under construction, ASPI suggests that the most economical solution could be to cut our losses. “For $5 billion, the RAN could buy two larger, more capable Arleigh Burke class destroyers with the latest Aegis configuration. In so doing, it would save money and possibly even receive the vessels before the upgrades to the AWDs are expected to be completed.”

The Turnbull government’s policy towards naval shipbuilding, the centrepiece of its innovation and ‘jobs and growth’ agenda, represents one of the biggest protectionist rorts in Australia’s long and chequered history of industry assistance. Yet, as in other areas, a protectionist industry policy is not what we would have expected of Malcolm Turnbull. As he stated at a book launch in 2012:

After all today, the Liberal Party is thoroughly committed to free trade. And yet while high tariffs are a thing of the past, we still spend billions supporting Australian industries with little analysis or understanding of its costs – politicians “save jobs” without any debate about how many other jobs are lost because of the public resources diverted.”

Yes, Prime Minister.

Jon Stanford worked in government for 25 years, being a division head in the Industry Department and latterly in the Department of the Prime Minister and Cabinet.

Comment by Hugh White

This is spot on.  I’d only add that acquisition strategy for the submarines almost guarantees a disaster whoever builds them, because the design and pricing are taking place in a completely competition-free environment.

What we need is a competitive Project Development Study phase, in which two (or more) contenders develop detailed designs and provide tender-quality prices on which a fixed price contract can be based. That is standard in this kind of project, or used to be.

As it is, DCNS can offer whatever they like at whatever price they choose to demand and we will have no option but to accept it – and the longer the current phase lasts the less option we will have, because the less we could be able to stand the delay of starting again.

Hugh White, 23 September 2016.

Hugh White is Professor of Strategic Studies at the Strategic and Defence Study Centre at the ANU. He was formerly Deputy Secretary of the Department of Defence.

 

 

 

 

 

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In a former life, Jon Stanford was a Division Head in the Department of the Prime Minister and Cabinet. Currently, as a Director of Insight Economics, he is undertaking significant research on Australia’s future submarine project, generously supported by Gary Johnston, owner of the Submarines for Australia website.

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