UK Defence and the 2018 Budget

The Ministry of Defence (MoD)’s sustained efforts over the past year to gain budgetary relief, led by Defence Secretary Gavin Williamson, now appear to have borne fruit. In his annual Autumn Budget Statement, published on 29 October, Chancellor Philip Hammond confirmed that the MoD will be allocated an additional £200 million during fiscal year 2018/19 and a further £800 million for 2019/20. This allocation will be in addition to already-announced allocations of £200 million of new money for 2017/18 and £600 million for above-plan Dreadnought spending for 2018/19. In total, the MoD has now been allocated some £1.8 billion of extra spending, over and above the allocation in the 2015 Spending Review.

The previous and current budgets are shown in the table below. By next year, the MoD core budget (excluding operations) will have risen in real terms for three successive years for the first time in more than a decade. At current rates of economic growth (around 1.5% per annum), the UK will continue to exceed the NATO target to spend at least 2% of GDP on defence by just over 0.1 percentage points.

Table 1: UK Defence Spending after the 2018 Budget

Fiscal Year

Cash £m

Real Terms £bn

Real-Terms % Change

% GDP (NATO Definition)

2015/16

34,734

36,178

 

2.06%

2016/17

34,681

35,339

-2.3

2.15%

2017/18

35,948

35,948

+1.7

2.11%

2018/19

37,360

36,699

+2.1

2.14%

2019/20

38,396

37,051

+1.0

2.13%

 

 

Sources: HM Treasury, Budget 2018, HC 1629 (London: The Stationery Office, October 2018), p. 36; ‘Memorandum for the Ministry of Defence Main Estimates 2018–19’; NATO, ‘Defence Expenditure of NATO Countries (2011–2018)’, PR/CP(2018)091, press release, 10 July 2018; authors’ calculations, using GDP deflator inflation figures from Office for Budget Responsibility, ‘October 2018 Economic and Fiscal Outlook – Supplementary Economy Tables: Table 1.7: Inflation’.

 

 

Notes: Spending numbers exclude spending on operations and the Conflict, Security and Stability Fund (CSSF). NATO-reported spending also includes spending on operations, CSSF, pensions and other items, trends in which are assumed to mirror those in core defence spending. The 2019/20 estimate assumes a £350 million net transfer to other government departments for cyber activity, in line with recent experience.

The biggest single factor in explaining the additional cost pressures on the MoD budget this year has been the increase in the cost of constructing the Dreadnought submarines, designed to carry the UK’s Trident nuclear missiles and due to begin entering service from the early 2030s. Spending on the Nuclear Enterprise as a whole (which also includes SSN attack submarines, missiles, warheads and running costs) now accounts for some £5.2 billion a year, or 14% of the total 2018/19 defence budget. The total budget for procurement of Dreadnought alone is £31 billion, with an additional £10 billion of contingency held by the Treasury. The additional £600 million already allocated to the MoD for 2018/19 earlier this summer, together with around half of the additional £800 million allocated for 2019/20, will be used to pay for Dreadnought costs running above previously budgeted levels. Overall, therefore, more than half of the extra £1.8 billion has been for unbudgeted Dreadnought costs. While the remaining £600 million for 2019/20 can be used flexibly, the chancellor’s statement emphasised the need for investments in cyber capabilities and anti-submarine warfare.

The added Dreadnought allocation should allow the programme to proceed at a more optimal and cost-effective pace, taking advantage of opportunities for cost-saving investments when they arise while accepting new costs when judged necessary. This flexibility will shield other MoD procurement programme from the destabilising effects which fluctuations in Dreadnought costs might otherwise have imposed on them. This is a welcome response to the dual risk that either other defence programmes would otherwise have been squeezed to pay for the deterrent or the pace of Dreadnought construction would have had to be slowed, incurring significant additional costs in the long term.

The additional funding should also allow the Modernising Defence Programme (MDP) process – now the longest defence review the UK has ever had – to be brought to a conclusion before work begins on the new cross-Whitehall defence and security review that will run alongside the 2019 Spending Review. The MoD has made clear that it intends to conclude the MDP by the end of 2018. It has not yet decided whether this conclusion will take the form of a full publication or (more likely) a Written Ministerial Statement. What is clear is that, because of the additional announcements in the budget, the MoD will no longer have to make the immediate reductions in capability – cutting Regular Army personnel numbers, scrapping amphibious ships and so on – that were being heavily trailed during the earlier phases of the review in late 2017.

Towards the 2019 Spending Review

Decisions on addressing longer-term pressures on the defence budget will have to wait for next year’s Spending Review.

There is no guarantee that the extra £800 million provided in the MoD allocations for both 2018/19 and 2019/20 will become part of the baseline for this new review. Most of this extra spending seems likely, at least notionally, to come from the Treasury’s £10-billion Dreadnought reserve, established as part of the 2015 Strategic Defence and Security Review. Logically, therefore, a similar allocation will be made in future years only if, and to the extent that, Dreadnought spending again comes in above planned levels.

As this week’s budget made clear in one of its less-noticed announcements, the Treasury is setting aside some £4.7 billion to pay for additional employers’ pension contributions across government (excluding the NHS and state schools), made necessary because of changes in discount rates. This will not increase immediate pressures on the MoD because it will be funded from the Treasury reserve in 2019/20, to the tune of some £600 million for the MoD in that year. But it will have to be financed from the MoD budget in subsequent years, and it will count against the 2% target.

The MoD is also likely to face greater pressures on personnel costs from the end of the previous public sector pay restraint policy. Already, the award of a 2.8% pay award to the armed forces for 2018/19 has meant an additional £180 million in pay costs, over and above budgeted provision. Similar levels of award in future years are likely to be necessary to maintain pay comparability with average earnings in the private sector. These will also require additional budgetary allocations.

On top of these additional personnel-related costs, the next Spending Review will also need to find  room for new investment in capabilities not so far included in MoD forward plans.

Defence has now moved near the top of the government’s priority list, with only the NHS (of the major departments) achieving comparable levels of real-terms growth this year and next. Beyond 2019/20, the government is committed to spending at least 2% of GDP on defence every year.

In the absence of a further worsening of the strategic environment, it remains unlikely that it will be willing to increase the proportion of GDP spend on defence. If the economy continues to grow at an average of around 1.5% per annum during the next five years – as the budget assumes – the most reasonable prediction remains that the MoD will receive the 0.5% annual real increases which it was promised in the 2017 Conservative manifesto. This would leave the UK spending some 2.03% of GDP on defence in 2022/23, assuming other NATO-counted spending (such as operations and pensions) increases in line with core MoD spending. This estimate also assumes that the £800-million budget addition for 2019/20 is not included in the Spending Review 2019 baseline, and that there are no further Dreadnought-related supplements to the budget.

Given the multiple upward pressures on both personnel and equipment spending, it would be hard to limit the overall budget increase to this level without some significant additional capability cuts and/or efficiency savings.

Yet the new resources made available for defence in this budget increases the possibility that the MoD could do better than the manifesto promised. Over the three years to 2019/20, including Dreadnought-related allocations, core MoD spending is now due to increase by an average rate of around 1.6% per year, broadly in line with average GDP growth of around 1.5% per annum as projected by the Office for Budget Responsibility. The Treasury has shown that it is willing to respond to the exceptional cost pressures which the MoD now faces. While the budget assumes that overall non-NHS departmental spending will not increase in real terms during the next Spending Review period, therefore, it may now be possible that the MoD could obtain annual real increases that allow spending to stabilise as a proportion of GDP.

Such an increase – still at the upper level of expectations, but more realistic than before - would be significantly more generous than envisaged for most other departments in the budget. The MoD would still need to make hard choices to fund an ambitious programme of transformation and modernisation. If obtained, it would be the most generous, and sustained, increase in the MoD budget since the early 1980s.

Before discussions start in earnest on the 2019 Spending Review, however, the government’s attentions will now return to obtaining the best possible deal in the negotiations with the European Union. For the MoD, as for the country, much now depends on whether the Government can deliver a Brexit settlement that avoids economic recession and maintains GDP growth at projected levels.

The views expressed in this Commentary are the author’s, and do not necessarily represent the views of RUSI or any other institution.

This Commentary was updated on 5 November 2018. A small amendment was made to the end of the third paragraph. With Dreadnought spending in 2016/17 coming in around £300 million above budget, total above-plan Dreadnought spending for these three years amounts to about £1.3 billion. This amendment was made to reflect the fact, however, that the additional £200 million provided for 2017/18 was not provided from the Treasury’s £10-billion Dreadnought contingency fund.