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The Spending Review, announced on Wednesday, has surprised the many commentators who thought defence capabilities would face further significant cuts. The Ministry of Defence has achieved a settlement that is substantially better than might have been expected.
This year's Spending Review, the results of which were announced on 26 June, was potentially fraught with risk for the Ministry of Defence (MoD). The 2012 Autumn Statement made clear that the two largest spending departments - Education and Health - would continue to have most (and in Health's case almost all) of their budgets protected from real-term cuts. Other departments, as a result, would have to share the pain of meeting the Chancellor's tough targets for further spending cuts in 2015/16. As the largest department not protected by a Treasury 'ring fence', the MoD appeared to be in the firing line for further significant cuts.
Given this starting point, the Ministry of Defence has achieved a settlement that is substantially better than might have been expected. The overall 'flat cash' settlement (Total Departmental Expenditure Limit (DEL) spending falling from £32.7 billion in 2014/15 to £32.6 billion in 2015/16) is not so different from the 'near-flat cash' settlement in the 2010 Spending Review (Total DEL rising from £32.9 billion in 2010/11 to £33.5 billion in 2014/15). In real terms, the 2.0% real reduction announced for 2015/16 is roughly comparable to the 7.5% real reduction over four years that was announced in 2010 (which equated to an average 1.9% annual reduction).
Of the total £74 billion of cuts made as a result of the 2010 Review, however, more than £51 billion would have been necessary even if the defence budget had been maintained in real terms through the decade up to 2020. The 2013 Spending Review, by contrast, started with a forward defence plan in which commitments and budgets were broadly in balance. This is the most important explanation for why the MoD has been able to avoid a repetition of the type of painful decisions (sharp reductions in personnel numbers, gapping of important capabilities) that resulted from the 2010 SDSR.
The MoD's position was helped by two further decisions in the early stages of the Review. First, because of the Government commitment to 1% annual real growth in the equipment budget, the target for reduction in the Resource Budget was calculated only in reference to its non-equipment portion (which is just over 70% of total Resource Departmental Expenditure Limit - DEL). Second, the Treasury's initial saving target for the MoD non-equipment resource budget was set at only 5% in real terms, compared with as much as 10% for other non-ringfenced departments. Taking these two decisions together, the Treasury's target for the MoD resource budget as a whole was for a real reduction of around 3.3% from 2014/15 levels.
Yet the MoD faced a further challenge. The 2012 Autumn Statement, published in December 2012, had announced an additional £490 million reduction in MoD's 2014/15 resource budget; and the Treasury insisted that the adjusted 2014/15 figure should be used as the baseline for the 2013 Spending Review. In addition to the 3.3% real reduction requested by the Treasury, therefore, the MoD had to find a further £490 million saving for 2015/16. Together, these two reductions would have required the MoD to find around £1.4 billion in savings in its planned 2015/16 resource budget.
Attempts to transfer some elements of the MoD budget to more protected departments (such as DFID, Health or Education) came to nothing, despite considerable speculation and commentary. Instead, the key to the MoD's ability to reduce the extent of its required savings was that it was able to argue successfully, during the last weeks of the Spending Review, for a commitment to no further reduction in service personnel, beyond those already under way as a result of previous plans.
This in turn was a primary reason why the MoD was able to persuade the Treasury to reduce the level of planned savings in its resource budget to £875 million, around £500 million of which was a carried-forward savings requirement as a result of the revised 2014/15 baseline. Some further reduction (equivalent to a 2.3% real terms reduction in total Capital DEL) was agreed in the non-equipment component of the Capital DEL budget. The MoD therefore had to find just over £1 billion in savings in total, equivalent to 3.4% of the total Departmental Expenditure Limit. This equated to a total real reduction of 2.0%, when measured against the revised 2014/15 baseline.
In principle it can be argued that, purely in terms of the potential effects on overall capability, it does not make sense to exclude service personnel numbers from scrutiny for possible savings. The political effect of the commitment not to make savings in this area, however, was to reinforce the case for moderation in the MoD's overall budget settlement.
The MoD's relative success may also have reflected a wider Government preference for security budgets, given growing concerns over the impact of the Arab awakenings, new cyber threats, and other related issues. The security and intelligence agencies benefited from this shift in mood, receiving real terms increases in both their capital and resource budgets. The commitment to the UN's 0.7% target for aid has been maintained for a further year, ensuring real terms increases for DFID (1.1% in its resource budget, 26% in its capital budget). Counter-terrorism budgets in the Home Office have also been protected. Of the main security departments, only the FCO has lost out, and faces further real cuts in 2015/16 of 6.3% in resource spending and 1.8% in capital spend.
The MoD's place in the departmental pecking order remains below those given to health and schools. As in 2010, however, it has retained a position that is significantly better than the Home Office, Justice Department, local government and business. The reduction in the MoD resource budget (1.9%) is, as a result, slightly more favourable than the 2.5% reduction in the total government DEL resource budget.
The challenges facing the MoD as a result of the Spending Review have been substantially reduced by the decision to exclude spending on new equipment procurement, around £7.5 billion of the total budget, from the process. It would, in any case, have been counterproductive to include procurement in a single year review, given MoD's past ability to flex such spending between years. Any move in this direction, therefore, could have been the first step in a slippery slope towards previous bad practices. At this Spending Review, however, the MoD has resisted this temptation.
The decision not to cut service numbers has also meant that the £9 billion of annual spending on service personnel has been largely off limits in the search for economies. Around £100 million was saved as a consequence of the decision to limit service pay increases to 1%, significantly below the previous planning assumption. Once again, as over the four years of the 2010 Spending Review, the decision to implement a regime of real salary reductions across the public service has been a major explanation for why capability reductions are less severe than they might otherwise have been, given the scale of budget cuts being made.
Because of this 'internal ring fence' on two key components of the MoD budget (together accounting for around 50% of total spending), other parts of the budget have had to take reductions that are significantly higher. The overall reduction against previous MoD plans, as explained above, was just over £1 billion (equivalent to 3.4% in real terms). But the agreed reduction in other spending (excluding service personnel and new equipment procurement) will amount to almost £1 billion compared to previous plans, a real reduction of around 6% in spending in these unprotected categories.
On the capital side, the MoD has accepted a reduction of just over £200m in its plans for non-equipment spending, primarily construction spending across the defence estate.
On the resource side, there are three further main sources of savings:
- First, the MoD will take £350m from planned spending of £7.5bn on equipment support (repair and maintenance of existing kit). This is seen as achievable on the basis of a number of pilot studies conducted by the MoD in preparation for the Spending Review. It is consistent with the findings of the NAO study on the Equipment Plan, which suggested that previous MoD cost estimates on the support budget were less robust than those for equipment procurement.
Given the weaknesses in existing procurement arrangements identified in the Government's recent White Paper, it remains to be seen whether the existing Defence and Equipment Support organisation will be able to deliver these savings without adversely impacting on capability. The timing of the required savings means that they will have to be achieved before any reorganisation, as a result of proposed reforms, is able to be of assistance.
The reduction in 2015/16 equipment support spending means that the Government is unlikely to achieve 1% real growth in total equipment spending in that year. Importantly, it also lowers the baseline from which 1% real growth in equipment spending for subsequent years is calculated. The Spending Review has reconfirmed the Government's commitment to 1% annual real growth in equipment spending after 2015/16. The Spending Review reduction in support spending, however, means that the funds earmarked to meet the target in 2016/17 and beyond will be less than they would otherwise have been.
- Second, around £100m will be saved from the £2.5bn annual budget on civilian pay. At present, it is not expected that the reduction in civilian posts as a result of this Spending Review will be more than several hundred. This number could increase as a result of further efficiencies generated by Government Procurement Service work on common goods and services (see below), or if civilian employees are transferred to other government departments as part of this process. After a period of five years in which MoD civilian numbers are planned to fall by almost 30,000, reductions on this more modest scale constitute a very significant flattening of the downwards curve.
- Third, around £300m are due to be saved from greater efficiencies in spending on IT and a range of other goods and services. Cabinet Secretary Jeremy Heywood has been closely involved in estimating the potential for generating such savings, using the expertise and negotiating power of the Government Procurement Service (GPS) to do so on the MoD's behalf. Both the MoD and the Treasury are convinced that such savings can be made. But issues remain as to how quickly such savings can be generated, and what the unintended consequences (including on military capability) could be from what will be a significant reorganisation. The assumption is that the organisation that will control this element of its budget (i.e. the GPS) should bear the financial risk (and/or benefit) involved. But some work remains to be done to clarify how this arrangement will work in detail.
The 2013 Spending Review has therefore left the MoD with a series of challenging tasks over the next two years, especially in the areas of equipment support and non-defence-specific goods and services. By focusing required savings largely in these two areas, the MoD has been able to protect the new equipment budget, and to take a respite from any further reductions in service personnel numbers. Even if there is some impact on military capability as a result of planned efficiency measures in support spending, therefore, the outcome of this Spending Review has been significantly better for the MoD than could have been anticipated when it began.
 The Spending Review settlement resulted in a 1.9% real reduction in the MoD's resource budget (Resource DEL) and a 2.3% cut in its capital budget (Capital DEL). HM Treasury, Spending Review 2013, Stationery Office, June 2013, pp. 10-11, 60. For discussion of the 2010 Spending Review and the MoD, see Malcolm Chalmers, 'Unbalancing the Force? Prospects for UK Defence after the SDSR', Future Defence Review Working Paper 9, November 2010. The outcome for the 2010 Spending Review period will differ somewhat from the 7.5% plan, as a result of changes in spending plans (notably in the 2012 Autumn Statement) and in projected inflation rates.
 Malcolm Chalmers, 'Looking into the Black Hole: Is the UK Defence Budget Crisis Really Over?', RUSI Briefing Paper, September 2011, p. 4.
 HM Treasury, Autumn Statement 2012, Stationery Office, December 2012, p. 58.
 This excludes Special Reserve Spending, due to fall from £1.8 billion to £1 billion. Spending Review, op. cit., p. 10.
 See Malcolm Chalmers, 'Mid-Term Blues', op. cit., for further discussion.
 Ministry of Defence, Better Defence Acquisition: improving how we procure and support defence equipment, Cm 8626, Stationery Office, June 2013.