Does New Zealand spend enough on Defence?

Line of Defence Magazine - Summer 2021/22

A United States Air Force C-130J. Image: USAF/Wikimedia.

Dr Wayne Mapp writes that if New Zealand is to provide its Defence Force with modern platforms capable of interoperability with partners, it will need to maintain defence expenditure at 1.5 percent of GDP over the next decade.

The new AUKUS security pact raises the question of whether New Zealand spends enough on defence. AUKUS proposes major new defence expenditure, particularly by Australia on the proposed fleet of eight nuclear powered submarines.

The United Kingdom will also have to spend more to build up its naval fleet, if it is to have a serious presence in the Indian and Pacific Oceans. The proposed Royal Navy fleet of eight Type 26 frigates and five Type 31 frigates is not nearly enough for such global aspirations. Similarly, with the seven Astute submarines, which is actually one less than the eight submarines Australia intends to acquire.

The Defence Assessment released on 8 December reinforces the point. AUKUS was the signal that Australia recognises that it needs new capabilities for the Pacific. The Defence Assessment, which specifically states that China is driving a more competitive strategic environment in the Pacific, should serve the same purpose for New Zealand. The Defence Assessment reinforces that New Zealand must replace the ANZAC frigates no later than the early to mid 2030s.

Australia and the United Kingdom have been increasing their defence expenditure for a number of years. In Australia’s case, defence expenditure has substantially increased from 1.6 percent of GDP in 2014 to 2.0 percent in 2020. The increase in the United Kingdom has come off a higher base, rising from 1.9 percent of GDP in 2017 to 2.2 percent in 2020.

In both countries there has been a real increase in capability, particularly in air and naval assets. Both countries have acquired the F35 fighter aircraft. The United Kingdom has two new aircraft carriers and Australia has three air warfare destroyers with some limited ABM capability. Australia and the United Kingdom are also in the middle of replacing their 25 year old frigates with new and much more capable Type 26 frigates.

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For many western countries, particularly in Europe, the last major expenditure programmes were toward the end of the Cold War. The major assets bought during this period are now thirty years old. As a consequence, most NATO nations are in the middle of acquiring major new equipment. The F35 aircraft is perhaps the most striking of these platforms, but it can also be seen in the push to renew naval fleets, both in submarines and new naval combat ships.

Defence expenditure can be calculated in a number of ways. The usual international standard, used by NATO, combines both operational expenditure and capital expenditure. Therefore, a major capital spending plan will drive up expenditure, even if operating expenditure and personnel numbers remain the same.

Major equipment programmes take decades to fulfil, and their capital cost is typically spread over many years. The standard NATO approach of assessing defence expenditure is to include capital expenditure as it is actually made. A period of substantial capital expenditure will drive up defence spending. Conversely when few capital items are purchased, overall defence expenditure will decrease.

The New Zealand approach to assessing defence expenditure has modified over time. From 1992 to 2018, capital expenditure was accounted for using a capital charge on capital equipment.

The capital charge, which was the sole recognition of capital expenditure, was included in the annual appropriation. The actual injection of capital to purchase the new equipment was little more than a footnote to the annual appropriation. The capital charge had the effect of allocating the cost of capital over the life of the equipment.

The overall effect was to reduce the apparent level of expenditure when compared to the usual NATO measure, which accounts for capital as it is spent. For instance, using the capital charge system, $1 billion of capital expenditure would only result in a $70 million annual capital allocation, based on a 7 percent capital charge. Though over time, increased levels of capital expenditure would progressively increase the overall level of capital charge.

The more recent approach, which conforms with the way that NATO accounts for defence expenditure, has been to include capital expenditure and capital injections as they occur within the overall calculation of annual defence expenditure. The ongoing cost of capital is still included as a capital charge.

The effect is that large procurement programmes, with their substantial capital payments, will substantially increase defence expenditure in the year in which the payments are made.

Nations with large and complex defence forces will always have major capital programmes in play and therefore will not have major variations of capital expenditure from year to year. Smaller defence forces, such as New Zealand’s, have much lumpier capital programmes.

The NZDF has relatively few large and expensive platforms, which are typically in service for many decades. The P8 Poseidon and the C130J Hercules that are being now purchased are replacing aircraft that are over 60 years old, though these aircraft have been upgraded over that time.

As a consequence of the both the increased capital required to purchase the new aircraft and the change in how to account for capital expenditure, there has been a rapid increase In New Zealand’s defence expenditure, up from 1.1 percent of GDP in 2017 when the only recognition of capital expenditure was through the capital charge, to 1.5 percent of GDP in the 2021 Budget which includes the actual capital expenditure as it occurs.

The 1.5 percent figure conforms to the NATO system of assessing defence expenditure. On the pre 2017 system of assessing defence expenditure, defence expenditure would have been a little over 1.1 percent of GDP.

Once these major purchases have been delivered and fully paid for, overall defence expenditure may decline as a percentage of GDP. However, the high cost of the new equipment will result in a higher depreciation allowance, so the defence budget may not fully reduce to pre-2017 levels, when assessed as a percentage of GDP.

It is noteworthy that both Australia and the United Kingdom are keeping their defence expenditure at their new levels, enabling continuing substantial new purchases of advanced military capabilities, particularly in their air and naval assets. The question for New Zealand is whether we should do the same. In doing so, the implication is that the defence budget should be kept at or near 1.5 percent of GDP, using the NATO measure.

Another way of looking at this is that it would mean that New Zealand would be able to spend around $1.8 billion on new capital equipment each year for the rest of this decade, or a total of $14 billion through to 2030.

The Defence Capability Plan of 2019, when Ron Mark of New Zealand First was Minister, forecast an expenditure track very similar to this, with $20 billion of new capital expenditure from 2019 to 2030. This plan did not envisage replacing the ANZAC frigates before 2030, though it did plan for replacing the P3 Orions, the C130 Hercules, the maritime helicopters as well as acquiring a substantial ice capable patrol vessel. The first phase of this plan is well underway.

The overall expenditure track of the Capability Plan, if extended through into the 2030s, is clearly sufficient to replace the ANZAC frigates with modern combat vessels, such as the Type 31 frigate currently being built for the United Kingdom.

In order for frigates to be delivered by the early to mid 2030s, it will be necessary to actually place the orders in the mid to late 2020s. A more competitive strategic environment, as forecast in the Defence Assessment, would indicate that three such vessels are needed, to ensure that at least one frigate is always available. Over the last twenty years, with two ANZAC frigates, there have been many occasions when neither of them were available for deployment.

If New Zealand wants a highly sophisticated Defence Force with modern equipment that is able to fully interoperate with our partners and allies, then the 2019 Capability Plan must be fully implemented. That means maintaining defence expenditure at 1.5 percent of GDP. The Defence Force will be essentially the same size as at present, but its equipment will be among the best of the small defence forces in the world. Anything less will mean an ongoing degradation of capabilities when compared to our partners and allies.