Blindfolded Tightrope Walking - Striking the MOD Funding Balance

The next week or two was supposed to herald the announcement of the long-awaited Integrated Review. This key piece of work, a specific manifesto commitment and vital part of the five yearly cycle of defence and security reviews was due to be published. Now it seems this at risk of not happening as planned.

The reason for the confusion stems from wider circumstances. It was originally intended that the Government would carry out the regular cross Whitehall comprehensive spending review, a chance for all departments to identify their policy goals, work out what resourcing was needed to deliver them, and bid for money on a multi-year basis. The result would be some financial stability, with budgets assured and locked down for several years to come.

To say that COVID has caused a challenge would be an understatement, and for spending it is particularly difficult. There is a not unreasonable argument that given both the wider challenge of managing the COVID response, and the need to identify what impact COVID, and to a lesser extent the post Brexit trading arrangements, have on the economic situation, that now is not the time to do a spending round.

Image by Ministry of Defence; © Crown copyright

As a nation we don’t know yet what the economy will be like in 12 months’ time, and it is particularly difficult at present to make any predictions. The challenge for the Chancellor is not overcommitting spending when there is no clear picture on what tax revenues will do.

Instead the most likely outcome is that there will be a series of one-year deals, intended as a ‘getting through this’ package, and then when the picture becomes clearer, a longer term review will be done. There is a mild challenge though in that if the Comprehensive Spending Review slips much beyond late 2021, then its life slips towards the date of the next election.

Without intending to stray onto the live wire marked ‘politics’, a 2020 spending review gives the Government time to conduct a second one in the mid term of this current Parliament to respond to policy priorities. A spending review that expires in 2024, gives the Government less time to manoeuvre ahead of the next General Election, which must occur by Dec 2024. It also means that its harder to easily settle a second follow on deal (essentially giving 6 years of commitments), as the timing will be so close to the election that the PM may wish to defer it until the result is known. This potentially means a further ‘one-year rollover’ in the near future.

For the MOD this poses a particularly thorny problem. The Review was intended to provide a clear statement of the current threats and challenges, and a look ahead to future issues too. Much like the 2010 SDSR set out the path to the ‘Force 2020’ (namely the armed forces we would require in 2020 which, by and large, has been delivered), the IR will probably set out a vision of Force 2030.

This requires changes in structures, force levels, equipment plans and so on. The military is clear that it can only change its top level endorsed policy with the approval of the government of the day – one reason why things got so challenging in the late 2000s was because there had not been a defence review since 1998 to offer changes to agreed defence policy outputs. This meant Defence was running hot trying to deliver against long unsustainable goals.

If the IR is delayed, then Defence cannot go ahead and make the changes required of it – for it is still obliged to meet the goals set in 2015. This means trying to maintain the same force structures and outputs, even if they are not as relevant – precisely because the Government has not changed its overall policy.

The IR will have been costed and set up to look at providing some level of assurance to the MOD that, if approved, they would have the funding in place for years to come in the programme to deliver various projects. For example, it could be that one outcome is to progress work on Army vehicles, that has been paused pending the outcome of the review.

This could happen because not only had the Review agreed the policy need for them, but it had also agreed the funding settlement to make it happen, and the money was ringfenced inside the MOD budget for the next few years to make it happen.

More widely the Review will also be used to withdraw certain capabilities from service or draw down equipment levels. This would enable the MOD to not only save money in the short term by taking equipment out of service, and not having to pay for it anymore, but also to accrue significant wider savings as a result.

For instance when the Harrier force was taken out of service, the MOD saved by not only deleting the aircraft type, it could scrap the maintenance and support contracts, close two airbases, reduce headcount more widely as a result of deleting multiple training courses (from operational conversion to maintenance work) and remove the need for things like retaining HMS ARK ROYAL in service (so freeing up wider savings in that regard).

The savings that can be accrued from withdrawing equipment are considerable and can make a real difference in difficult financial circumstances. They can also be used, depending on whether the Review is permitted to ‘recycle’ the savings back into the Defence Budget to then fund new capabilities elsewhere.

So, when CDS talks of both ‘sunset’ and ‘sunrise’ capabilities, he refers to both taking kit of out of service, and finding the way to bring new equipment in. But this is dependent on the money, political will and policy guidance being there to do this.

If the MOD has to carry on with the existing SDSR2015 guidance, then it cannot begin this process of change. It will be required to fund capabilities it wants to take out of service, and it won’t be able to start the process of reinvesting this money elsewhere to upgrade and better equip the military.

The wider problem too is that Defence is facing, to put it mildly, a large financial black hole. The NAO has written at length about the significant unfunded liabilities in the Equipment Programme that need to be dealt with, and which in the worst instance total some £15bn of unfunded costs.

Part of the reason for carrying out the IR was to help sort this funding mess out and get the Department back on to a more stable financial setting. Again, this was contingent on removing some things from service, scaling back aspiration in the Equipment Programme (so changing the policy ambition to do something, which in turn reduces the amount of equipment needed to support it) and generally trying to tidy up the financial challenge.

In an ideal world what would happen next is that the IR would set this aspiration out, and then do so against a properly costed and funded multi-year spending agreement. However, if this can’t be reached, the MOD still has to do something about its short-term cash flow problem.

Either the Treasury will agree to be benevolent and ‘buy out’ the problems by providing extra cash to make the budget solvent. Or it will insist that more is done internally to save money and make the problem go away. The chances of the Treasury doing the former is slim, while the latter means that the MOD will be forced to implement significant defence cuts to balance the books.

If the latter occurs, this poses a real challenge for Defence. It will be cutting for the sake of in year financial expediency, and not as part of a properly organised plan. There will be no certainty that the savings made now will be rewarded in future spending rounds by a settlement that permits funding all the things that the MOD wants to do as part of the IR. In turn this means the carefully balanced and calibrated force structures, change plans and lofty aspirations to move and embrace new technology will not be able to proceed (at least in the short term).

The worst outcome here is that the MOD finds itself forced to make cuts that don’t make sense, to solve an in year crisis and not have the certainty of funding or policy top cover to begin making the changes it wants to make.

This will have ripple effects felt for several years not just in the MOD but across industry more widely. For example, if the MOD is now unable to sign contracts, then the defence industry will not be able to start work on them as planned, potentially building in delays, or in worst cases, forcing the competition to restart if prices are no longer valid. That is assuming of course that the various component parts of the industry survive, particularly in the middle of a global recession.

The MOD may find itself in a situation whereby it has got to reduce force levels and planned purchases but hasn’t got the ability to commit to future plans. It may also need to run on other assets longer than planned, spending money that would have been reprioritised instead to keep legacy equipment going, rather than spending it on transformational activity.

The biggest risk of all is perhaps that the IR outcome is announced, with a clear roadmap of what the Government ambition is across all national security departments, but there is no funding settlement to underpin it. Aspiration without funded activity is perhaps the worst of both worlds, as the MOD will know what it needs to do, and will need to begin the process of downsizing and changing force structures, but without any certainty as to what comes next to fund its longer term aspirations.

In this scenario, the MOD finds itself having to conduct a series of year on year mini settlements aimed at keeping itself financially stable, and trying to fund an ambitious defence review, but without knowing what next year looks like. This means planners will constantly have to reprofile funding, or carrying out the dreaded ‘defer, delay, descope’ to keep the budget in line with the in year totals, slowing down procurement and making it harder to fund projects on a multi-year basis.

Industry will respond in kind, unlikely to welcome an extension of the famine/feast principle whereby Defence may have to splurge in on year, but then turn off or drastically reduce spending on a project the next. This is not going to reduce costs but will burn goodwill and increase the perception of MOD as an unreliable customer.

The MOD is not alone in facing this challenge – other departments will also have made plans for activity based on the outcomes of the IR, for example spending on conflict stability activity, or enhancements to cyber security. But the MOD with its combination of large people headcount, expensive shopping list and serious existing credit card bill to pay off is the one which will be most deeply affected here.

In terms of what happens next, it is likely that there will be a week or two of posturing by various Ministers and departments, likely accompanied by some leaks. There may well be a fudge of some description, with commitment to some but not all projects on a multi-year deal.

 For seasoned Whitehall watchers, this will be a fascinating test of the relative strength of the No10 & No11 teams, and see what is taken as a higher priority – is it balancing the books and getting finances onto a secure footing, or proceeding with the fully funded outcome of the Review? Decisions need to be taken soon, but at this point there is, arguably for both teams, everything to play for…