Prognosis for defence spending after Budget 2010

By Professor Malcolm Chalmers for RUSI.org

Summary

Previous RUSI analyses have estimated that the most plausible central scenario for the future defence budget is a 10-15% real terms reduction over the next six years.  This central scenario has now been revised in light of the announcements in the Budget. It is now estimated that the core defence budget could be cut by up to 15 per cent in real terms over the next four years.

Given the difficulties involved in making sharp and rapid reductions in procurement spending, the personnel budget will have to bear a significant share of this cut. It is therefore projected that there may have to be a reduction of around 15 per cent in total Ministry of Defence (MoD)personnel numbers, including cuts of 30,000 in military personnel and 13,000 in the number of MoD-employed civilians. Further discussion of the policy choices that these reductions will require is provided in previous RUSI studies.[1]

The Budget

The Budget delivered to Parliament on 22 June confirmed that most of the burden of reducing the UK's record budget deficit will be borne by spending cuts. It also confirmed previous commitments to protect health and overseas aid spending.  As a result, in the absence of further savings elsewhere in the forthcoming Spending Review, the average reduction in the spending of other, 'unprotected', departments - including defence - will be 25 per cent in real terms over the four years to 2014/15.

Defence can draw some comfort from the Chancellor's acknowledgement in his Budget speech of the 'particular pressures' facing the education and defence budgets. This may be an indication that these two areas will be asked to accept smaller reductions than other unprotected departments.  Even so, given the high proportion of unprotected expenditure that they consume, neither education nor defence will be able to avoid severe reductions over the next four years.

Protection and Defence

• The total 'unprotected' budget for departments (total unprotected DEL) is £250 billion in 2010/11.[2] If this unprotected budget is reduced by 25% over four years, as the Chancellor proposes, it will fall to £190 billion by 2014/2015.
• The Chancellor has made clear that the Spending Review will seek further savings in the budget for Additionally Managed Expenditure (AME), over and above the £11 billion in annual welfare savings already identified in the Budget, and that any such savings would be used to reduce the size of the cuts to departmental budgets. If economic growth is below projected levels, welfare spending on unemployment-related benefits could be higher than assumed. For the purposes of this estimate, however, it is assumed that a further net reduction of £13 billion in the AME budget is made by 2014/2015. This might be made possible, for example, through increased public service pension contributions, abolition of winter fuel payments and pensioner bus passes, and/or restrictions in child benefit eligibility.
• If the Government can achieve a further £13 billion in AME spending cuts, the budgets for unprotected departments would 'only' have to fall to £203 billion by 2014/2015, a reduction of around 20%.  The main areas between which this reduction would then have to be shared are education (£89 billion), defence (£40 billion), public order and safety (£35 billion), personal social services (£32 billion) and transport (£22 billion).[3] These account for 87% of total unprotected spending.
• If the Government decides to give better-than-average treatment for the education and defence budgets, this would necessarily be at the expense of other unprotected departments. Yet cuts in excess of 20% in public order and safety (i.e., police, prisons, courts and fire services) will also be difficult to achieve in this timeframe, even if the government adopts radical cost-cutting measures (for example, in relation to sentencing policy). Steep reductions in spending on personal social services (for example on care for the elderly and disabled, and on child protection) would also encounter considerable resistance.   
• As part of Spending Review preparations, departments are soon likely to be given indicative budgets by the Treasury. Their final budgetary settlements, however, may not be known until the Review is published on 20 October 2010. The most optimistic scenario for defence is probably one in which spending on defence and non-tertiary education is cut by 10% over four years (broadly 'flat cash'), leaving other unprotected spending - police, prisons, higher education, social services, etc. - to be cut by an average of 26%.[4] A 15% cut in defence and non-tertiary education may be more plausible, although even this would still leave other unprotected departments with an average reduction of around 22%.  

The Pay Freeze and the MoD

Because existing contractual obligations make it hard to quickly, and significantly, reduce the proportion of spending that goes on equipment, it will be hard to increase the proportion that is spent on personnel. The freeze on public sector pay for the next two years, including spending on armed forces pay, will therefore provide some welcome relief for MoD planners.

As a result of the pay freeze, it is projected that the average cost of MoD personnel will rise by only 0.7% per annum over the next two years, well below economy-wide inflation of 2.1% per annum. This estimate assumes that 25% of the MoD workforce, accounting for around 15% of MoD personnel spending, will receive the flat-rate £250 annual increase promised in the Budget. Because members of the armed forces (up to 1*) will continue to receive annual pay increments, it also assumes that sharply reduced levels of recruitment will lead to 'incremental drift' in average military pay levels throughout the next four years.

It is possible that the Armed Forces Pay Review Body will seek to restore previous private-sector relativities for military personnel once the pay freeze ends in 2012/13, not least because of concerns over recruitment and retention. For the purposes of constructing this estimate, however, it is assumed that no significant pay 'catch-up' takes place during the next four years. Instead, it is assumed that real military pay levels are increased by 2% in real terms in both 2013/14 and 2014/15.

The aggregate effect of these assumptions is that, over the next four years, average MoD pay levels increase by around 12%, compared with an increase in general prices (measured by the GDP deflator) of 9.8%.[5] If, as our central scenario suggests, total real spending on personnel falls by around 13%, total personnel numbers would therefore have to fall by around 15% by 2014. Total personnel numbers would then be reduced from 283,000 to 240,000. If spread proportionately, this would lead to a 30,000 cut in military personnel numbers, together with a reduction in civilian personnel numbers of around 13,000.[6]

NOTES

[1] Malcolm Chalmers, 'A Question of Balance? The Deficit and Defence Priorities', Future Defence Review Working Paper 7, June 2010.  This and other RUSI briefings are available at www.rusi.org/fdr

[2] Total DEL in 2010/11 is £380.0 billion, from which £122 billion in UK health spending and £8 billion in total aid spending is deducted.

[3] Budget 2010, p. 5.

[4] This is the scenario highlighted by the Institute for Fiscal Studies. Rowena Crawford, Public Services: Serious Cuts to Come, IFS, 23 June 2010. For the purposes of this calculation, 'schools' includes all non-tertiary education spending.   

[5] Budget 2010, Table C5.

[6] As of March 2010, there were 197,840 armed forces personnel (of whom 19,620 were untrained). There were also 85,590 FTE civilian personnel in post in March 2010. Source: Defence Analytical Services Agency.