Last week, George Osborne, the British Chancellor of the Exchequer, unveiled the results of a wide-ranging review of spending, designed to bring the government’s share of the economy down from today’s 47.5 percent to 41 percent by 2014–15. In the main, the review’s results are welcome, though they do not go far enough.
Unwisely, though, the government included defense spending—which had already taken a beating from the previous Labour government—in its review. The result, as defined by the government, is that after inflation, defense spending in Britain will shrink by 7.5 percent by 2014–15. To put it in terms of pounds sterling, the government plans to spend 24.3 billion pounds in 2010–11 and 24.7 billion in 2014–15 on defense programs and administration. If it simply wanted to keep up with inflation, which the government estimates at about 2 percent annually, it would need to spend upward of 26 billion pounds.
There are reasons to be skeptical that the government will meet its 2 percent inflation target for the overall economy. In its Pre-Budget Report, the government estimated that inflation would fall to close to 1 percent in 2011, but by June, it was forecasting over 2 percent inflation. But whether or not the civilian economy achieves the government’s target, it is extremely unlikely that that inflation in the realm of defense will be only 2 percent. This is because of what is known as “defense cost inflation.”
“Defense cost inflation” is the tendency of costs in defense to grow faster than those in the economy as a whole. Defense costs tend to do this for two reasons. First, like any employer, defense departments—in the U.S., Britain, and elsewhere—have to pay wages, and these usually grow faster than inflation. Second, procuring advanced defense equipment poses technical challenges, and overcoming these challenges usually involves costs that grow faster than those for equipment that you can buy off the shelf.
The result is that, as Britain pointed out in its latest Strategic Defense and Security Review, issued earlier this month, there are “systemic pressures” on defense spending. The Defense Review did not estimate the size of these pressures on the defense budget as a whole, but stated that, in military pay, they amount to between 1 and 2 percent annually.
Unfortunately, while the Defense Review states that the budget takes account of this fact, the published figures do not appear to reflect any adjustment for it. The real decline in defense spending in Britain will thus be more than 7.5 percent. If defense cost inflation is 1.5 percent annually, the real decline will instead be on the order of 13 percent. In terms of pounds sterling, Britain would by 2014–15 need to be spending about 28 billion pounds, instead of 24.7 billion pounds.
Defense cost inflation is not easy to measure, let alone calculate in advance. But the fact is that the British government admits its existence, but does not appear to include it in its calculation of the declining purchasing power of the money it plans to spend on defense through 2014–15. That means that, by that date, Britain will be buying even less defense than it says it plans to. That is not a good thing for Britain, for the U.S., for NATO, or even for the cause of accurate accounting on defense spending.
At the least, the British government should clarify its treatment of defense cost inflation. Or, better, it should couple its acknowledgement that defense cost inflation exists with a commitment to ensure that defense spending in Britain is protected against its effects over the life of the current Parliament.