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Tuesday 20 Feb 2018 | 12:24 | SYDNEY
Tuesday 20 Feb 2018 | 12:24 | SYDNEY

Opportunity cost in Australia's future submarine decision



6 October 2015 13:51

I'm only too ready to leave it up to strategic experts such as Rear Admiral Peter Briggs to sort out how many submarines we need. I'll stick to the economics. We shouldn't let the number be determined by a perceived need to provide work-continuity for ASC in South Australia. And we should acknowledge that this is a decision about 'guns or butter': spending more on submarines by building them at home means less of something else.

The Senate inquiry on the future of naval shipbuilding in Australia is a 'must read' for anyone interested in the decision-making process. It's an example of Australia's own version of Eisenhower's 'military-industrial complex' in operation. Even though this was the Senate Economics Reference Committee, the list of contributors is almost exclusively construction-industry representatives, regional lobbyist, trade-unionists and former services personnel. The taxpayers were under-represented. 

Reading the testimony, you might get the impression that the Collins saga had been a brilliant success and that building a new fleet of submarines in Australia would be no dearer than building overseas, an assertion consistently refuted by actual domestic ship-building experience (See ASPI's 'Four ships for the price of six').

Members of the Committee would have been courageous (in the 'Yes Minister' sense) to have been critical or sceptical, as all political parties covet those South Australian votes. Even so, the report was not, as Admiral Briggs stated, unanimous. There was in fact a substantial dissenting report issued by the Government members of the Committee, which (inter alia) specifically addressed the issues I raised in my initial post on this issue.

In response to the recommendation that Admiral Briggs quotes, the dissenting report says:

Response to recommendation 3. The draft report calls for an Australian build at all costs. This could give rise to national security outcomes being compromised by a prioritisation of industry policy over defence policy and it could force the taxpayer to underwrite an economically uncompetitive project. While we want to see the Future Submarine contract awarded to Australian shipbuilders, it must also be the result of a competitive tender process and it must be awarded on merit. This will ensure that Navy receives a fit for purpose product of the highest standard while Australian tax payers receive the best possible value for money.

. . .Recommendation 3 effectively relegates national security policy to second place behind industry policy.

I couldn't have said it any better.

The substantive difference between Peter Briggs and me relates to the impact of spending on submarines on the economy. It is standard practice for consultants-for-hire to make their lobbying case on the basis that spending on the target industry will boost the economy, not just by the amount of the actual expenditure, but by a multiple of this because of successive rounds of spending. This is akin to the familiar textbook multiplier process. You can go one step further (as the 'eloquent' testimony of Professor Goran Roos does) and double-count the contribution of sub-contractors. If you want to get a good reception where 'jobs and growth' are the paramount political concern, this is the way to go.

It is only in rare circumstances, however, that this makes any economic sense. The multiplier logic relies on squeezing more than a pint out of a pint pot. The implicit assumption here is that there is unused capacity in the economy – capital, managerial talent and unemployed workers – all ready and waiting to respond to this extra demand to build submarines, adding to GDP in the process. Not only are these resources assumed to be unemployed now, the assumption is that they would have remained so over the life of the project.

Of course Australia has unemployment – currently 6.2% of the workforce. But this is close to the lowest level of unemployment Australia has had for the past quarter-century. It would be nice to get back to the lower level we had at the height of the resources investment boom, but this kind of fine tuning is not feasible.

The proper way to analyse how the submarines might affect GDP is to think in terms of opportunity cost: if these resources – capital, managerial talent and labour – were not building submarines, they would be doing something else which society also values. The productivity challenge is not to attempt to conjure productive capacity out of thin air, but to shift the economy's given resource endowment into uses which have a higher social value.

Government industry policy (subsidies, 'picking winners' and so on) may play a part in that process. Economists are not all free-market ideologues. Some of us accept that governments can sometimes use their considerable expenditure to steer resources into areas which will catalyse higher-value output and have longer-term benefits even when the expenditure ends. But economists also look back on the history of infant industries which never grew up, and on politically driven white elephants. Who wants another Darwin-Alice Springs railway? 

Where does domestic submarine construction fit in such a framework?

Will this foster a viable industry which suits our comparative advantage? Will it form the nucleus of a cluster of highly productive firms with a self-sustaining future when the submarine work is finished? Will it link into international supply chains, thus compensating for our lack of manufacturing scale? Will it be disciplined by international competition, or link us more firmly into the rising demands of East Asia?

The Collins-class experience suggests that constructing bespoke submarines is a dead end, a mendicant industry whose survival depends on government subsidies.

Does it make any difference that domestic construction avoids importing? In a globalised world with flexible exchange rates, this 'exports good, imports bad' argument, common though it is, has to be dismissed. The flexible exchange rate looks after the need to keep imports and exports in equilibrium with the available funding from capital flows.

The dissenting report of the Senate inquiry was a brave attempt to put some limits on the size of the hand-out, through giving the rival bidders some flexibility on the domestic content of construction. The competitive evaluation process seems the last opportunity to impose some economics on this politics-driven project.

Photo courtesy of Australian Defence Image Library.

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