Following the 2023 defence strategic review and in the face of an increasingly challenging security environment, Australia’s long-standing goal of building sovereign industrial capacity has taken on new urgency. But the lofty ideal has never been matched with a clear and focused plan. It will be once again redefined in the upcoming defence industry development strategy. What does it take to generate the indigenous capacity Australia needs to protect itself and its interests in the region?
A recent report from Nioa Group (et al.) offers policy recommendations for how Australia might go about doing so. The main recommendation comes as no surprise: ‘Buy more of our stuff, faster.’ Irony aside, the argument is not entirely without merit. More demand will indeed drive more supply, and Ukraine has demonstrated the importance of wartime expendables. But it will do little to create the structural changes that will allow Australian businesses to move up the value chain. It will do little to create the robust markets required to sustain a modern fighting force.
Other recommendations are less useful. The report proposes divorcing defence industrial policy from integrated force structure planning and spreading components of it across a range of government departments. It proposes creating a free-for-all in which ‘…the actual military users of systems and technologies in the ADF work as closely and directly as possible with the developers and makers….’ Such proposals are unlikely to enter into serious debate by those who understand the joint warfighting and logistics environment.
A third recommendation gets more at the heart of the issue: establishing industrial policy settings that enable the rise of Australian prime contractors. This would indeed make a difference. By definition, primes use scale and expertise to create sophisticated, integrated systems that can’t be cobbled together piecemeal.
But the recommendation is also not terribly helpful. Its logic is circular, for surely an environment in which a prime contractor can thrive possesses a high level of independent capacity. The Boeings and Raytheons of the world do not rely on commodities to maintain their market position. If simply opening the spending tap wider won’t do it, what will? How can Australia make a prime?
The answer will be uncomfortable for many. It involves symbiotic relationships between government and industry that walk a fine ethical line. The short answer is this: primes grow through regulatory capture.
It starts when defence departments contract with businesses on joint efforts to develop advanced military capabilities. A company that helps develop a product has an enormous advantage in any subsequent production contract; awards are often sole sourced. It also has advantages in winning future work that builds on the original government-funded effort. Incremental progress is the nature of R&D. Subsidised investment enables competition with international counterparts enjoying similar advantages. Exports drive further profitability.
Early movers win. The secret to solving Australia’s productisation problem? Unfair advantage. Thus, the snowball begins to roll.
Other factors cement a prime’s position. Governments fear the monopoly power of companies who sell them bespoke equipment, so they carefully monitor profits and margins. Small companies can’t compete with big ones when margins are thin. Economies of scale kick in, and big fish eat the little fish. Regulations pile up when companies produce lethal hardware; only large companies can afford the legal departments to remain compliant. Indeed, governments often must rely on industry advice when writing those regulations.
The fact that an ethical line must be walked does not imply that it is crossed (although this certainly happens). Governments face similar challenges in many industries that produce natural monopolies, from energy to infrastructure. It is their job to manage market failures that prevent free and open competition. That job involves difficult tradeoffs. But there is a reason that many people speak of the military-industrial complex as an unmitigated pejorative.
So first, Australia must decide if prime contractors are really what it wants. Fostering them would require a radical re-think of processes for developing and procuring military capabilities. Dual-use goods won’t do it. Commodity munitions won’t do it. Defence must take the substantial innovative capacity of its economy and build walls of classification around critical components (sorry—no tiptoeing around sketchy university departments). It must bring in private companies on cost-plus R&D contracts and form long-term, collaborative relationships.
The Defence Science and Technology Group must stop being a hobby shop for academics and their pet projects. The scientists must be dethroned, and their expertise subordinated to operators. Engineers must rise in prominence, taking more leadership roles as program managers and contracting officer technical representatives. What DSTG lost in scientific rigour, it would gain in operational execution.
Public-sector expertise must give way to private-sector expertise as Defence outsources large proportions of its R&D, allowing capability to grow in the contractors who will one day take those products to market. It must retain ownership of core systems while leveraging contractors’ internal R&D so they can create their own intellectual property, grow their own portfolios, and win in international markets.
All of this will require difficult short-term decisions. The current budget mix of R&D versus procurement dollars is inadequate. Barring increases to the top line, that means less money can be spent on immediate operational needs. Prioritising investment over consumption builds wealth in a national economy no less than an individual pocketbook.
Is all of this what Australia wants? The US defence industry takes justified criticism. Reform proposals that imagine we can have all of the benefits while avoiding all of the costs are unhelpful. Generating some level of sovereign capability does not require Australian prime contractors; however, it requires a far more nuanced strategy that acknowledges the unavoidable limitations of living in a $2.3 trillion economy rather than a $35 trillion economy.
It requires clear-eyed and consistent commitment to an alternative trajectory. Critical manufacturing, technology and IP requirements must be narrowly defined, and their output integrated with the operational plans and supply chains of trusted partners.
Above all, it requires acknowledgement that even these measures come at a cost. Comparative advantage is real, as are gains from trade. Buying indigenous capacity as part of a broader national security plan must incorporate reasoned decision-making akin to buying a new piece of hardware. Throwing money at the problem may be good politics, but it is poor strategy.
George Henneke is a visiting senior defence economist at ASPI. Image: Department of Defence.
The Strategist — The Australian Strategic Policy Institute Blog. Copyright © 2023