Treasury Committee
Oral evidence: Defence spending and finance, HC 16
Ordered by the House of Commons to be published on 3 June 2026.
Members present: Dame Meg Hillier (Chair); Dame Harriett Baldwin; Chris Coghlan; Jim Dickson; John Glen; John Grady; Dame Siobhain McDonagh; Catherine West; Yuan Yang.
Questions 1 - 91
Witnesses
I: Lucia Retter, Assistant Director, Defence & Security, RAND Europe; Andrew Kinniburgh, Director-General, Make UK Defence; Max Warner, Senior Research Economist, Institute for Fiscal Studies.
Witnesses: Lucia Retter, Andrew Kinniburgh and Max Warner.
Q1 Chair: Welcome to the Treasury Select Committee on Wednesday 3 June 2026. We are looking today at defence spending and financing, and how the UK is prepared for the challenges ahead.
Before I start today’s session, though, I do want to pay tribute to the three crew members on the Royal Navy helicopter that crashed in the early hours of this morning. It is very sad that those three crew members have lost their lives, and the thoughts of this Committee and Parliament are with their family and loved ones.
I would like to welcome our witnesses today. We are pleased to have in front of us Andrew Kinniburgh, who is the director general for Make UK Defence, representing a number of the SMEs that contribute to our defence manufacturing; Lucia Retter, who is the assistant director for defence and security at RAND Europe; and Max Warner, who is a senior research economist at the Institute for Fiscal Studies. The Institute for Fiscal Studies is a very regular attendee at our meetings.
We are looking at this issue because of the challenges facing the world. Whatever our sister Committee, the Defence Select Committee, does on this, the challenge is always that a lot around defence depends on the money that is available. The Government have set out their defence strategic plan, thanks to Lord Robertson and colleagues of his who worked on that. It sets out three core roles for UK defence: defending the UK and our overseas territories; deterring and defending in the Euro-Atlantic; and shaping the global security environment. We also have a long-standing and ongoing commitment to the independent UK nuclear deterrent, which takes up a large chunk of the money available for defence.
First, I want to ask each of you in turn what you think is the actual gap between what we need to do to deliver on those objectives and the money available, and whether we are being realistic about what we can achieve with the money available. Perhaps I could start with you, Mr Kinniburgh.
Andrew Kinniburgh: Thank you for inviting us. We are very grateful to have this opportunity. My organisation represents just under 1,000 defence companies. That includes all the big primes, but we cap our subscriptions with the big primes specifically so we can be an independent voice and speak on behalf of SMEs as well as larger companies.
I will be the first person to mention the defence investment plan, just to get us warmed up. We hope it may come out next week. Without the DIP in place, we are stuck on 2.6% of GDP, which we argue is wholly unacceptable and not enough to give us a credible defence deterrent, in effect, if that is what we focus on in terms of our military capability.
There is definitely a gap. We need to see that plan go from 2.6% to 3% and then from 3% to 3.5%. Of course, we must not forget the 1.5% on defence infrastructure. As I am sure the Committee knows very well, the second you introduce a new submarine, you are not only building a new submarine, but maintaining it in Devonport and operating it from Faslane submarine base; you are effectively building three sets of infrastructure for one piece of equipment. We would like to see that plan to 5% really rammed home very quickly.
The big question is how big the black hole is and how much of that black hole Treasury will look to claw back. There is no point in us having a plan to 3% or 3.5% if it is going to get clawed back because there is a black hole from previous years. We have a significant challenge there.
Q2 Chair: Of course, we have seen other defence money being put in and then spent on all the different black holes in the MOD at different times. From the point of view of the businesses you represent, some of this will be taxpayers’ money, but businesses are private enterprises and they make profit out of this. It was drawn to my attention that small businesses in particular often have very small overdrafts or lines of credit from high street banks. Is there an issue about how private finance is available to some of your members in order to make sure that they have the financial strength and capability to stand up for what they need to do to procure?
Andrew Kinniburgh: There undoubtedly is. We survey our members every year, and one of the things that we track is ESG—environmental, social and governance—measures. In particular, we track the views of financial services companies and the services that they provide to our members. From last year to the beginning of this year, we went from 11% of our members having problems to 17%.
Q3 Chair: Could you expand on what you mean by “problems”?
Andrew Kinniburgh: For instance, being debanked, not being able to get an overdraft, or not being able to get the working capital they need through various means, whether that is venture capital, private equity or traditional retail or business banking.
Q4 Chair: Is that because of a desire to disinvest from defence industries or are there other reasons for it?
Andrew Kinniburgh: That is the killer question. There is a muddying of the water here. If you have a shaky balance sheet as a business, the bank is going to question you anyway. There is an element of weakness in some of our member companies. There is no question but that is an issue. It is how you draw the line between the lack of the defence investment plan, the lack of defence spending and those shaky balance sheets.
Q5 Chair: Are you saying that if the defence investment plan is produced with a clear timeline attached to it, it might improve private finance for a number of your members?
Andrew Kinniburgh: From our perspective, it will give confidence to all the markets. Even companies such as Lockheed Martin, Boeing or indeed BAE Systems, the home team, are all looking at where they should invest their money. Should you put it into the UK, Germany, Poland, the Baltics or the US? The problem at the moment is that because we are in this paralysis, those companies are simply not going to put money into the UK until they see the defence investment plan. My job is to shout loudly from the rooftops about how good the UK is as a great place to invest.
Yes, it is certainly slowing things down, but giving that confidence to the market and to financial services institutions would be a huge plus point. We would then probably see the brakes being let off in terms of overdrafts and working capital, and being able to get a bit more flexibility.
Q6 Chair: Lucia Retter, what is the gap?
Lucia Retter: We know that the strategic defence review was costed against an assumption that there would be a rising line from 2.5% of GDP by 2027 to 3% in the next Parliament. This was before the Hague summit and before the commitment to 3.5% of GDP by 2035.
The assumptions in terms of defence capabilities that are baked into the SDR are already outlining what the gap is between that and what we have. They span everything from readiness to stockpiles, so making sure that the armed forces have the depth—the medical services, the infrastructure, the munitions, the stockpiles—to face a protracted conflict, if it came to that, and sustain a high intensity of operations. There are also some gaps in digital technological integration, being able to develop and field autonomous systems at scale and being able to fully integrate the equipment that we have.
There are perennial delays in fielding capability on time. There are gaps not just in getting equipment on time but in being ready and deployable at the time that we need it. Those gaps were outlined in the SDR. Again, they were costed against a slightly different baseline if we are to assume that we get to 3.5% later.
Ultimately, I would argue that the implication of the current gap at the strategic level is that our deterrence posture is more brittle than we would like it to be. Our messaging and signalling to both allies and adversaries is undermined because of that gap. The investment in our defence industrial base, which arguably is a deterrent in itself, is also limited because that money is not yet being committed or released.
Max Warner: I do not have a lot more to add on the gap between capabilities and spending, but there are two really important points. First, as Lucy said, the strategic defence review’s terms of reference were quite clear that it was supposed to be affordable within lower defence spending than we are currently planning to get to. The Government accepted all its recommendations, but now it seems that everyone more or less agrees that it is not affordable. That is quite striking.
Secondly—we are already talking about this—a lot of focus goes on what you are spending as a share of GDP and what defence spending is, but we should not get too focused on that. What really matters is what we are getting for that money.
Q7 Yuan Yang: That follows on to my question, which is about the pros and cons of having this target. Of course, it is a part of the NATO agreement, but in terms of the management of spend, are there downsides as well as upsides to having this overall target?
Max Warner: It is not how we typically manage public spending. There are a few areas where we think in terms of percentage of GDP targets. You will see a common thread: defence, international aid, and now we have a deal with the US Government that medicines spending in the NHS is linked to GDP. We tend to have GDP percentage targets where there are international agreements because it is easier across countries to think about spending that way.
As I say, it is quite different from how we normally plan public spending. Indeed, the MOD still has a cash budget set at spending reviews, just like every other Government Department. There are some potential risks we should be aware of with a percentage of GDP target. The first is having a target for spending rather than a spending budget. They sound quite similar, but they are a little bit different. If you are trying to make sure that you definitely spend over that target, on the margin you might worry that you would be more likely to spend money less well because the target is the spending rather than having a budget that you are trying to deliver within.
The second is that, of course, we do not know what GDP in the future will be. It does rely on forecasts, so there is a little bit of uncertainty there. That is not a first-order risk, though. The first one is perhaps more important.
Q8 Yuan Yang: How have you seen those effects play out in comparable countries with similar supply chain issues to ours? Can we compare the distortionary effects from having a GDP percentage target? For example, there has been some commentary about inflation in the defence supply chain caused by needing to get a lot of money out quickly and the pace of defence spending. Do you see any evidence of that and any analogies for the UK?
Max Warner: We have not looked in particular depth at other countries, but you are right. Something we should be concerned about, or at least aware of, is that it is not just the UK that is increasing defence spending. Lots of countries are increasing defence spending at once. As a kind of simple model, if industrial manufacturing capacity was fixed for defence equipment, you would expect the prices to go up and we would get the same, but of course, it is not fixed. There is expansion. The key question is how responsive that can be. If industrial capacity can be very responsive and we can easily shift manufacturing into defence, we maybe should not be too worried about those price increases, but we should at least be aware that, with everyone increasing, price increases are a risk here.
Lucia Retter: One thing that I would add is that there is a question about the absorptive capacity of the industrial base in terms of investment. Increasing defence investment is about not only the capital investment into the industrial base, but the investment in people and in the broader infrastructure, where perhaps you are not facing quite as many challenges around specific inflationary pressures that potentially arise.
Q9 Yuan Yang: Is your argument, then, that investing in infrastructure, skills and training generally has a lower inflationary effect than investing in other parts of the supply chain?
Lucia Retter: I would think so. The long-term benefits of investment need to be targeted towards regional development, skills development, R&D and the development of intellectual property. Again, how much inflationary pressure is generated depends on where the money goes.
Q10 Yuan Yang: Going back to the gap that our Chair was asking about, is there a quantitative assessment of that gap between target and spending in terms of bottom-up budgeting in the SDR? Is there any work that you are aware of, Ms Retter?
Lucia Retter: I am not aware of any. In fact, we have not seen an equipment plan since 2024. We do not necessarily know. We are very much hoping to see some of that in the—
Q11 Chair: There was a £14 billion gap in the equipment plan over the 10-year period. That has been fairly static.
Lucia Retter: Last time, the NAO identified a £16.9 billion gap. At the moment we do not know because we have not had the most recent equipment plan. In fact, we have all been waiting for the DIP to supersede that.
Q12 Yuan Yang: We need to have that plan before we can even assess how much money we are lacking. Is that your sense of things?
Lucia Retter: Yes.
Andrew Kinniburgh: Just to touch on the GDP debate, one of the problems that we face in defence is that surety of demand, the demand signal. The way that we always describe it is, “Don’t touch the brakes. Once you have got going, let it run. Support it and let it run.” That is not at any cost, of course. We need to be sensible about this.
The problem with GDP fluctuations is that even £200 million or £300 million, which I know is a huge amount of money but in defence terms is relatively small pickings, can impact these really big programmes where you are designing a submarine for 10 or 15 years before it comes into service. Just even looking at the brake pedal, far less touching it, has a big ripple effect through both affordability and delivery in terms of the key deliverable milestones.
If I may, on the inflation side of things, I would agree that infrastructure and skills are probably less affected. If you look at something like welding, the cost of welders is now through the roof. If you are a nuclear-rated welder in industry and you are working on a nuclear power plant, for instance, you can be commanding six figures. It is extremely difficult for defence companies to compete with that because the sector does not create enough profit to enable you to do that.
Q13 Chair: Are there still camps training welders in places such as Czechia? There was a period where there were training programmes for welders to enter so that the British nationals who could be security cleared for more high-end defence projects were then moved over. It was backfill, basically.
Andrew Kinniburgh: There is a team of 300 welders from the Philippines working for Babcock at the moment. I would argue that it should be 300 or, in fact, 600 apprentices. You will have 300 retiring because the average age in manufacturing is creeping up quite rapidly through the 50s. We need to be investing now.
Again, you come back to the demand signals and the defence investment plan. Am I going to take on 500 or 750 apprentices, like BAE is doing, if I am not sure of where the demand is coming from?
Q14 Chair: Just to remind us, how long does it take? If I were to start training as a welder tomorrow, how long would it be before I could do the high-end stuff?
Andrew Kinniburgh: That gives me the perfect opportunity. For the standard big defence company, it would be a four-year apprenticeship. You would go through your various levels and then you would come out as a highly trained manufacturing apprentice. You would then perhaps go into project management or various different branches.
What you could do to address welding specifically, is do a one-year NVQ 2 or SVQ 2 and focus in on a single skill within the discipline of welding. You can then start producing people really quickly. In fact, we have a programme called the defence welding employment programme, which is looking to take kids off the streets. It is for young people who are either in the criminal justice system or at risk of entering it. We are working with a number of defence companies to try to see whether we can get them to do two or three weeks of work experience and then go into a one-year apprenticeship. At the end of that, they are working, they are earning, and they have somewhere to live.
Q15 Chair: So the lead time could be shorter than four years.
Andrew Kinniburgh: Absolutely, yes. It could be a year.
Q16 Chair: But you need the certainty of the defence investment plan.
Andrew Kinniburgh: Yes, correct.
Q17 Yuan Yang: Just to go back on the apprenticeships issue, is the issue right now a lack of people applying to become welders or a lack of places for them to train and get those qualifications?
Andrew Kinniburgh: It is a weird market because the big companies are massively oversubscribed. You are getting a lot of young people with three As at A-level who could quite happily go into university, but who have perhaps seen the light in terms of the costs, loans and that kind of thing. The big companies are very heavily oversubscribed. For SMEs, it is much harder. We are also seeing a little bit of a pattern where apprentices graduate in an SME, but then there is an element of the bigger companies snapping them up. That is not good behaviour, but it is market economics. It is a tough one.
Q18 Yuan Yang: To go back to the questioning around inflation, there are some really stark examples of how much inflation in the supply chain has gone up, partly due to improvements in defence technology. For example, the amount it costs to buy one modern fighter jet would have bought 310 Spitfires back in the 1930s. As somebody who represents SMEs in the supply chain, how much of this cost inflation can be tackled by increasing competition and breaking into areas of the supply chain where there are currently dominant monopolies?
Andrew Kinniburgh: It is a very good question. I would argue that the more SMEs you use, the more your inflation will drop because you are saving huge amounts of money in terms of overheads and infrastructure. Clearly, you are not going to have an SME priming a nuclear submarine, but there are lots of elements of that that could use SMEs both directly from the MOD and through the supply chain, as you move through the tiers.
We are very encouraging of the MOD. It has set up something called the Defence Office for Small Business Growth, which is specifically trying to help the MOD get better at spending with SMEs, but we think it lacks ambition. We want it to be much more ambitious and to have some procurement levers so it can impact what is happening on the ground. Using more SMEs will save you a lot of money.
Q19 Yuan Yang: Ms Retter, is this historic increase in prices down to better technology or is it also down to market structure that can be improved?
Lucia Retter: It is both. RAND has done quite a lot of work, including in the United States since the 1950s, tracking what cost increases in defence programmes have looked like and where they come from. We have identified that there are different reasons why the costs of programmes overrun or increase significantly.
One is cost escalation between generations of equipment. As you mentioned, for example, in terms of fighter aircraft, the cost of Tornado was much lower per unit than the cost of Typhoon, and the cost of GCAP is going to be much higher than the cost of Typhoon. That is due to a number of different things.
There is general economic inflation, the general rise in input prices. There is also a defence-specific layer on top, which is about technological complexity, so the need to use unique materials or the different manufacturing processes. You are paying more for your workforce if they need to be security cleared or to have special equipment or infrastructure. These are all extra input costs that you do not see in other sectors. You also find that there are other reasons why costs increase, which are due to programme management, whether that is risk not being managed properly, workforce challenges or other technological challenges.
There are many reasons why there are rising costs in defence. There are also many ways in which you can mitigate them, for example by placing longer-term contracts such that you allow some economies of scale. In defence, we are seeing a dwindling of the numbers that are being procured over time. If you look at number of fighter aircraft, ships or submarines, all of them are going down. The opportunities to have economies of scale are really diminishing compared to even 20, 25 or 30 years ago.
The way to break out of that is to instil better management of those programmes and to create opportunities for scale, for example, through multinational programmes. With the Type 26 global combat ship, the UK and Norway are now going to share the 13 ships that are being produced. Again, that creates a good opportunity to produce more at scale so that each of those ships can become more efficient. You can produce them more efficiently because you are learning from the first class to the second to the third. You are learning as you go.
There are opportunities to tackle it, but there is a bit of a cycle in defence, which we have observed over the last 20 years.
Q20 John Glen: I just want to discuss the ramping up of defence spending, what it implies and how it gains credibility. The Government said they want to get to 3.5% by 2035, and we are at 2.5% or 2.6% now. Treasury, and most Governments, usually do three or four-year spending review cycles. If the Government say, “It is going to be 3.5% in 2035,” so several years away, how is the credibility of that aspiration secure, given that the cycles of the Treasury will never project that far ahead?
What does that need to look like from an industry point of view? Is there any precedent? If NATO is expecting, as I understand it, an annual incremental path to reach this goal, what would you expect to see from the Government by 8 July, whenever the summit is? Mr Kinniburgh, would you like to address that point around what credible growth in spending would look like, please?
Andrew Kinniburgh: Yes, I will have a bash. There are a couple of examples internationally. I will get myself into hot water immediately by suggesting that the Australians have a 10-year plan that is pretty clearly laid out. What I am not clear about is whether the Australian equivalent of the Treasury has the levers of power on that or whether that is a committed 10-year plan. Certainly, from an industry perspective, for all of the reasons we have talked about already, that would be a huge boost to defence spending.
We need to be really careful not to fall into the trap of saying, “We will backload this. We will just do a tiny incremental increase for the next few years, and then at the end we will suddenly put a load of money in.” Talking to Lucia’s point, it is the R&D and the science and technology that you do today that will help you to improve productivity and other things like that. We should not be lulled into thinking that backloading the defence budget to get us 3.5% by 2035 is a good idea. It is a disaster.
If I may illustrate it with one little example, there is a tiny company of 30 people that has designed an automated robotic welding jig for a very large defence company. It is going to save the big company £35 million over the next 10 years. That illustrates it perfectly. It has an order book because it is involved in nuclear submarines. There is an order book there that is measurable. When we get the opportunity to invest in productivity, if we do it well, we can really accelerate things.
Q21 John Glen: I just want to get to the bottom of the question. What depiction of spending from the Government over the coming years would give credibility to their stated intent to get to 3.5%? What does that look like in five weeks’ time?
Andrew Kinniburgh: Do you mean the actual numbers?
Q22 John Glen: Yes, and the profile per year. You have said you do not want it backloaded. What I am trying to get at is how much they would have to spend each year going forward to be credible for the industry.
Chair: Can you spend it that quickly?
Andrew Kinniburgh: Yes, there is that. That is certainly a challenge.
John Glen: Before we get into that, what does that look like?
Andrew Kinniburgh: I am not sure I can answer that question, to be honest.
Q23 John Glen: I do not understand what you are really asking for, then. You want certainty in the increase, but you cannot tell me the profile of what the increments need to look like year by year, over one year, two years or three years.
Andrew Kinniburgh: It depends on what the equipment programme asks for, does it not? We are not just asking for a block of money. It depends on what capability we are required to deliver for the military.
Q24 John Glen: How do we as a Committee hold any Government to account in terms of making the goal real so that your expectations can be met?
Andrew Kinniburgh: I am not sure. That is the honest answer.
Lucia Retter: To add a different angle to this, in this type of conversation it is useful to look at what our European partners and allies are doing. There is an element of signalling and public messaging that is quite important. If you look at, for example, Germany’s commitment to increase GDP spending, it has gone into quite some depth in outlining what the profile will look like and what it will spend it on. If you look into the detail of—
Q25 John Glen: Will we get that here?
Lucia Retter: I would hope so. I would like to see that because that is exactly what needs to come out into the public domain: very clear signalling, both to our allies that we are committed to NATO and to our adversaries that we are committed to increasing our defence capability, as we have outlined in the SDR.
If it gets backloaded, there are risks associated with that in terms of potential cancellation of the programmes. There might be a new Prime Minister, a new Government or who knows what. The risk in backloading all that spending, from a deterrence and defence perspective, is quite significant.
Q26 John Glen: I understand what the DIP needs to do in terms of giving specificity to the capabilities, but I am trying to get at what the distribution in years 1, 2 and 3 looks like to be credible for industry to absorb that and make progress towards capability fulfilment.
Max Warner: I can see the value of certainty by setting out 10-year plans for industry, but it is not an unambiguously good thing to do. The Government do not, in general, set out plans for 10 years of spending. Again, there might be benefits, but there are costs. The Government tend to want to leave themselves some freedom to respond to economic, political and fiscal changes. Indeed, two or three-year spending plans end up changing quite a lot. Spending review plans change all the time. If we did set out 10 years of cash budgets, it is not clear to me how credible that would necessarily be.
There might be a middle point where we set out some intermediate targets, but I am not sure it would be reasonable to expect the Government to give defence budgets for the next 10 years.
Q27 John Glen: As politicians, we put a lot of store in 3% or 3.5%. “When is it going to be 3%?” You are saying that, though that is linked to our international commitments with NATO, any detail is not really particularly relevant beyond the next few years.
Max Warner: It can be. That is why we have a 10-year defence equipment plan or defence investment plan. Crucially, those—
Q28 John Glen: They are not matched by meaningful commitments, and they are not likely to be.
Max Warner: Defence equipment plans in the past have said, “We have spending review plans for the next couple of years, and this is what we are going to assume about defence equipment expenditure.” Until we get to the spending review where we set MOD budgets, we will not know what the MOD’s budget will be in seven years’ time.
Q29 John Glen: Could I ask you, Mr Warner, about the achievability of this amount of money? As I understand it, at the moment the Chancellor has indicated that she will offer £10 billion over four years against a £28 billion equipment shortfall. From an IFS perspective, what structural spending reductions or revenue-raising measures are going to be needed to make this happen?
Max Warner: I will not comment on particular numbers because lots of media have talked about lots of different ones.
Q30 John Glen: If I may say, you are the authoritative voice on this, are you not?
Max Warner: It may be worth talking about 3.5% of GDP, if that is a useful starting point, and we can think about different orders of magnitude for different options. The Government have already set out a plan at the spending review to get defence spending to 2.6% of GDP in 2027-28 and remain flat for a year. If you wanted to get to 3.5% of GDP, that is in the order of £30 billion to £40 billion on top of that. That is roughly £500 per person. It is a useful to think about it per person. That is quite a big increase.
Q31 Chair: Is that per adult per year?
Max Warner: Yes. Relative to 2.6%, to get to 3.5% by the end of this decade or the middle of next decade, it is around £30 billion to £40 billion more per year or £500 per person.
Q32 Chair: When you say “per person”, do you mean “per adult”?
Max Warner: No, I mean per person.
Chair: So for a family of four—
Max Warner: It is approximately £2,000. It is a big increase in spending. That is equivalent approximately to taking the entire Department for Transport budget or just under the entire Home Office and MOJ budget and adding it on top of the MOD budget. That is a big increase.
In tax terms, to give you a sense of the magnitude—there are lots of ways you could pay for this—it would be 3p to 4p on all rates of income tax or, instead, 3p to 4p on the standard rate of VAT.
Q33 Chair: You could put VAT up to 23% or 24%, or—
Max Warner: Yes, that is illustrative. You have lots of options.
Chair: If you put 3% to 4% on VAT, you might reduce people’s spending. That is interesting.
Q34 John Glen: The fiscal position is well understood, in that the borrowing restrictions are pretty much maxed out. Unless you increase those taxes, as you have described, or a similar basket of taxes, you have to make pretty significantly different spending decisions elsewhere, do you not?
Max Warner: Yes. You have to accept either that the state is going to get bigger by about 1% of GDP, because that is the increase, or that we are going to squeeze other areas of spending and not expand the size of the state. Crucially, the increase here is big enough that you cannot do it with some salami slicing or a bit of efficiency saving. These are chunky savings that you would need to make.
Q35 John Glen: Hitherto, the initial increase that we have seen from this new Government has been by cutting international aid from 0.5% to 0.3%. Do we have clarity on what that saving funded in terms of the MOD budget?
Max Warner: That was how it was presented, but it is a little more complicated. Money is, of course, quite fungible. Almost all the increases in defence spending have been investment spending. Crucially, investment spending is treated somewhat differently by the current fiscal rules. Quite a lot of the additional investment spending is coming from borrowing, and there have been tax changes and spending changes. You cannot separate out the one policy change that paid for it. It is more the whole change in the fiscal position.
Q36 John Glen: The political argument that was made was that the Government were having to make this very tough decision on international aid. Indeed, a very respected Cabinet-attending Minister resigned from Government because that choice had been made. You seem to be saying that it is not clear where that saving was spent.
Max Warner: Cutting international aid does save the Government money, of course, and the Government did increase spending on defence. Those two things did happen. Lots of other things happened too.
Q37 Chair: It was not cut from one and given to the other.
Max Warner: Exactly, yes. It was not that those exact pounds were moved across, but, of course, in the Government’s balance sheet they cut some and they did increase some.
Q38 John Glen: I have one final question on this element of the uplifting. If all goes well, the 3.5% commitment is secure, we get a defence investment plan and those increments are true in the first spending round, that is quite a rapid increase in quite a short amount of time. Mr Kinniburgh, could you address the issue of the industry being able to efficiently absorb and do something useful with that? There is a risk. Some people say, “If we give you all this extra money, you will spend it somewhat recklessly or less efficiently.” How would you address that?
Andrew Kinniburgh: You are absolutely right. That is one of the challenges for Germany after increasing its defence budget. It simply cannot spend it quickly enough. Just briefly on Germany, we attended a meeting of Ceemet, which is the European collection of manufacturing associations. Germany was also saying, “We are not getting the defence budget quickly enough.” It is similar to the UK, although perhaps we are seeing a different thing in the newspapers.
There are two elements to this. There is quite a bit of UK defence industrial capability not being used by the UK at the moment. If I give you an example, MSI Defence Systems in Norfolk makes naval guns. They are on hardly any UK ships. They are on US naval ships and coastguard ships; almost all of them have a gun manufactured by MSI Defence Systems in Norfolk. We chose Bofors of Sweden for our ships. There is some untapped capability in companies that are not being used by the UK at the moment. Weaving is another area—
Q39 Chair: Let us take that example. Could they, as Mr Glen said, suddenly ramp up and produce enough for the Royal Navy? If they are producing them for other people, have they reached their manufacturing capacity? How long would it take them to manufacture the extras, if they won the Royal Navy contract?
Andrew Kinniburgh: In that example it would probably not take very long, to be quite honest, because the volumes for the US are so high that the additionality for the UK would be relatively small.
Q40 John Glen: We all seem to think that everyone will be satisfied—NATO and President Trump—that we are on this trajectory to increase spending. What I am trying to get at is that, if you do not have the capacity in the workforce and the industry, either you will end up importing a lot more or you will not be able to absorb that extra money efficiently and it will not lead to the increase in capabilities that presumably is the collective aspiration.
Andrew Kinniburgh: If I could come at your question from a slightly different angle, there is also untapped potential in the UK manufacturing supply chain. We are still a really big manufacturer, as you know. We are 11th in the world at the moment.
We could repurpose the supply chains from companies such as Jaguar Land Rover, Nissan or Toyota. If we go down the road of manufacturing very high volumes of drones, whether it be air, ground, subsea or surface drones, the opportunity to use those kinds of companies, which are very skilled at driving costs out of manufacturing, offers a real opportunity in terms of both improving productivity and increasing capacity.
We should not be hidebound by the size of the defence industry today. There is great opportunity to surge. Those companies would very much welcome that, judging by the number of new members we have coming from automotive, oil and gas, and other areas.
Q41 John Glen: That is a reasonable answer, but history tends to suggest that, whenever there has been a surge in money, there has been a problem in terms of accountability. Ms Retter, can you address that? Are there lessons from elsewhere that we could draw on?
Lucia Retter: I am not sure I can address whether we have learned any lessons, but I was just going to add to Andrew’s point about manufacturing. It is often forgotten that we are not just in it to buy ready systems or get the end product. The investment also needs to come into the industrial capability and capacity. There is lots of room for improvement there because we have some facilities that really need to be upgraded and manufacturing processes that need to be improved, automated or robotised.
There are investments that perhaps do not necessarily result immediately in the product, but they will give us the ability to surge production should we need it, and give us greater resilience from a manufacturing perspective. Even if it is not just buying more kit—I am not necessarily advocating that we always need to buy more kit—we certainly need to invest to be more resilient and better able to surge, such that production is more effective and more efficient. It is also the investment into that.
A country that perhaps can offer some lessons, although it is really early days, is Poland, which has very starkly increased investments in defence and defence budgets. Initially, it spent a vast majority of that on imports. In fact, statistics show that it increased its imports by 800%. It is insane. Basically, Poland had a whole shopping list of equipment that it was trying to buy in order to replenish stocks for Ukraine and it realised that it had to upgrade its overall armed forces.
Poland is now transitioning from that import-heavy model into one that is much more focused on the domestic recapitalisation of the industrial base, and collaborative arrangements, for example, with South Korea, joint partnerships, technology transfer, collaborative co-production and things like that. Perhaps that helps.
Q42 John Glen: I have one more question for Mr Warner. Lord Robertson said that we cannot defend Britain with an ever-expanding welfare budget. What scope is there for cutting the welfare budget in favour of defence spending?
Max Warner: There is a political question about what you think the priorities should be. Any Government have the capability to cut welfare spending. There are many different levers within the system. We talked earlier about the big increase in defence spending and the scale. You would need to make serious changes to welfare policy if you wanted to deliver that. That would be a political choice that could be made here.
Q43 John Glen: Would that be consistent with manifesto commitments given?
Max Warner: I am not an expert on welfare spending, so I would want to avoid saying anything too much more on that.
John Glen: It goes to the heart of it in terms of being honest and real about this. Lord Robertson did a massive piece of work with a multidisciplinary team, which included Treasury expertise. He made quite a profound statement. How else do we interpret what he said, if we cannot get to the bottom of where this money is coming from? We know the borrowing rules are not going to move. We know that tax is at a record level. What conclusions should we draw about how this is going to be achieved?
Q44 Chair: Mr Warner, you talked about the £500 per person that would fund the increase from 2.6% to 3.5%. That would be a hefty cut in the welfare budget, if it were coming just from there.
Max Warner: These are the right questions. Fundamentally, spending a lot more on defence is a valid political decision, but it has consequences. The last time we spent 3.5% of GDP, in the late 1980s, we spent a lot less, about half of what we spend now, as a share of GDP, on the NHS. We spent less on welfare; we spent 4% of GDP in the late 1980s and roughly 8% now.
You have a societal question. If we want to put more of our economy’s resources into defence, where are those going to come from? They have to come from somewhere. Either we accept that the state is going to become bigger and we are going to raise taxes quite substantially to pay for that, or we say we do not want the state to expand and we are going to have to cut something quite chunky elsewhere. This is a really important societal question, if we want to have higher defence spending.
John Glen: You have very eloquently set out the problem. I am not sure we have quite got to the solution, but thank you very much.
Chair: Dame Harriett Baldwin might have some thoughts on that.
Q45 Dame Harriett Baldwin: I am going to get into wider defence procurement questions, but I wanted to start by asking Mr Kinniburgh one question. On 1 July, the Government are bringing in a 50% tariff on certain types of steel imports. Is that likely to raise the cost of procuring anything for defence?
Andrew Kinniburgh: Yes, it is. We are very concerned about that. I know that the final figures have not been agreed in terms of the weights of different types of steel, but we absolutely need to make it very clear that there are hundreds of types of steel, as I am sure you already know, and we make only a relatively small number of those types of steel in the UK. I am absolutely not advocating for Chinese steel being dumped on the market and us buying it up. In fact, we are very critical of the MOD, particularly the Defence Infrastructure Organisation, because it is still spot-buying pretty standard steels which we make in the UK from China, which I find unacceptable. We should be buying British steel.
It is a serious concern for us. If I give you an illustration, Barrett Steel, which is a steel stockholder and quite a big one, deals in a particular specialist steel quite heavily. It buys around 4,000 tonnes of that specialist steel every year. A lot of it is for the defence market. The steel tariffs trip out at 1,000 tonnes, but that is one steel stockholder buying 4,000 tonnes. Apparently, the entire UK tariff-free element is 1,000 tonnes. We have very serious concerns about that.
Q46 Dame Harriett Baldwin: What is the Make UK Defence position on this? Should we delay?
Andrew Kinniburgh: We should negotiate. The position is to illustrate, negotiate and come up with a practical solution. UK Steel is part of the Make UK family. We are very much working together with it to try to fix this problem.
Q47 Dame Harriett Baldwin: Thank you for the diversion. I just wanted to now get on to the wider defence procurement issues. Having been a Treasury Minister and having been the Defence Procurement Minister back when we had an equipment plan, I am appreciative of how challenging this is.
One of the big challenges is that, for a lot of the procurement you are doing, Ms Retter, you are basically buying from one supplier. It is single-source procurement. I wondered whether you could point to any good examples of how other countries procure their defence equipment better than the UK. Are there examples of good practice that we could learn from here in the UK?
Lucia Retter: That is a tricky question. Many Committees have looked at procurement and at what works well and what does not. It is fair to say that procuring defence equipment and defence systems, including digital systems, is one of the most complex activities that one can undertake. There are a lot of stakeholders and a lot of cost estimation is involved. Especially in a country such as the UK that develops a lot of this indigenously, you are looking at contracts that can span 15 or 20 years between research and development, the early stages of development and all the way to being in-service. It is a very complex business.
Are there countries that do it better? That is a really tricky question. Most countries in Europe do not develop very many systems indigenously. Very often, they tend to procure either commercial off-the-shelf equipment—equipment or systems that are available on the market—or modified off-the-shelf equipment. They ask for some requirements to be changed or for some modifications. In and of itself, that is quite a different proposition because you can more often than not run a more competitive process. You are not necessarily limited to a single supplier. For more complex programmes, such as naval ships, submarines or combat aircraft, yes, you are often limited to a single supplier and you start to rely on the single-source regulations and oversight that is there.
Where we see good practices, in particular more recently, is when countries adopt, where they can, a competitive process or at least engage with multiple suppliers to get a sense of what is available and how that would meet their requirements. They also have some sort of independent assurance, whether that is within the system, like we have in the NAO or others, or through red-teaming—having teams to challenge some of those decisions.
What I have seen, particularly in northern Europe, is that, as countries are investing more in defence and recapitalising more, they also invest a bit more effort into that scrutiny. Even if it happens at a faster pace and in a squashed time period, there is still a focus on making sure that the process is run well and there is as much scrutiny as is possible within the timeframe, while accepting that at the end of it we want the outcome, which is the capability that we are trying to achieve.
Q48 Dame Harriett Baldwin: There are major reforms under way at the moment with the national armaments director and the way that we procure in defence. How is that going, Ms Retter?
Lucia Retter: It is quite early to say exactly what the impact of these changes will be. There have definitely been many reforms of defence procurement since the 1960s. Ultimately, they have all been trying to get at the same thing, which is to make procurement faster, more efficient and less wasteful.
If I were to be optimistic, now we are under much more external pressure from wider geopolitical developments, we really need to get this right. To get this right is not just about improving the process or segmenting procurement, which is the current step. The fundamental enabler is a change of mindset and culture. That is the hardest thing to get. The officials within the procurement system need to be empowered to make decisions without layers and layers of approvals, comments, edits and requirements changes, and to stick to the timelines that the current procurement model should have, which is two years to contract for major systems and three months for commercial off-the-shelf equipment.
To achieve that is not so much about new structures or processes; it is the mindset, culture and accountability change, which is the hardest to implement. When we see progress, it will be because there is more external pressure to do that, like we see with urgent capability requirements or Operation Scorpius, when we had to provide equipment to Ukraine really quickly. Because there is that pressure, things just move much more quickly and there is higher risk tolerance, which enables that to happen.
Q49 Dame Harriett Baldwin: It is about giving more decision-making power to people lower down the procurement chain. That is what I am hearing. It is not about the national armaments director; it is about empowering people to take quicker decisions at a lower level.
Lucia Retter: It is very much bringing the end users, so the warfighting community, the actual end users of the equipment, together with the providers, the industry, as early as possible, such that the capability being procured is going to be suited for the warfighter. There have been many loops and hoops that took that element of immediate effect very much out of the picture. It is about bringing back the ability of the end users to engage with the industry, to understand what is in the art of the possible in terms of the solution and then move as quickly as possible through testing to the solution. Yes, I agree, an element of decentralisation would be really useful.
Q50 Chair: It has yo-yoed backward and forward from the commands to the centre and from the centre to the commands. Is there enough fiscal discipline? If you are the person closest to the ground and you want the men and women who are serving our country to get the best, there can be a danger of gold plating. That is their priority, rather than the money. How do you square that?
Lucia Retter: It is always like that. There has always been that back and forth. The US has exactly the same system. RAND has done a fair bit of work to understand the different requirements and processes. It has historically been back to the centre and then back to frontline command. There is a balance to be struck, but certainly, in terms of speeding things up, it is about identifying where you can cut the lengthy process and the levels and levels of approvals, particularly from communities perhaps that do not need to be involved, and being really quite ruthless in prioritising, from the top, what we need and how those individual capability plans fit into that.
Q51 Dame Harriett Baldwin: Mr Kinniburgh, have your members seen any difference in how things are being procured since this defence reform and the national armaments director were put in place?
Andrew Kinniburgh: I would love to tell you it has transformed and we are in the sunny uplands. We are on a journey. I absolutely agree with Lucia in terms of the culture change. That is probably the biggest thing.
Without going where angels fear to tread, I would suggest that perhaps we pay our civil servants a little bit better because the disparity between industry salaries and civil service salaries is enormous. That is a challenge because, not at all to decry the hard-working civil servants in the MOD, they are not very well paid in many cases and they are fronting up to very sophisticated commercial animals in industry. It is a really tough thing to negotiate between the two. The MOD does very well in many ways.
We are hearing some encouraging noises. The National Armaments Group will certainly help, as Dame Meg said, to bring together the overall requirements. For an unmanned one-way effector drone, the British Army, RAF and Royal Navy should be procuring together. There might be some different equipment fits, but the fundamental core capability is the same in effect. I will no doubt get several phone calls after I leave this room.
We are seeing some good practice. Commercial X, which is part of the Defence Digital part of MOD, has developed a much faster procurement model. It does not always work. You cannot apply it to everything, but, to give you an example of the old way of doing it, Filtronic is a company that makes antennae for spacecraft. It had an MOD contract that was 100 pages long. It was very long. For an SME, you need to get a lawyer in. You have to pay them to plough through all that detail, reject some things and then work out the payment terms, and all that kind of thing. With SpaceX, for pretty much exactly the same technology, the contract was 10 pages.
Commercial X, in Defence Digital, has an eight-page contract. We are really encouraging people in the MOD, such as Jim Carter, who is the director general commercial, and Victoria Cope, who is the digital commercial director, to ramp that up and move that forward. If we are being really adventurous, let us stick it into the Defence Office for Small Business Growth and give it some levers to test these things and really accelerate them. There is some light at the end of the tunnel, but it is a long old tunnel.
Q52 Dame Harriett Baldwin: Indeed it is. Ms Retter, are we procuring the right sort of equipment? Earlier, you mentioned ships and some of the other major programmes. There is the global combat air programme. Should we be focusing on other things, such as munitions or more autonomous equipment, as we just heard from Mr Kinniburgh?
Lucia Retter: My answer is that we probably need to focus across the piece. The UK has always maintained, at least to some level, what one would call full-spectrum capability. That is not to the same depth as the United States, but we have generally maintained our naval and air capabilities as well as autonomous systems.
There is a bit of a danger, in some circles, of focusing very strongly on autonomy fixing everything and being the answer to everything. There is also an assumption that the way in which the war in Ukraine is currently being fought is the way that Russia would fight a NATO country, which is wrong. It is very much not clear that that is how a potential conflict would unfold.
When thinking about the capabilities that need to be invested in, it is going to have to be a broader picture. Investing in autonomy covers anything from lethal autonomous systems to autonomous systems for surveillance, logistics or anything else. The Ukrainians have been extremely innovative in how they use autonomy.
We also need to make sure that we are still able to deter through the nuclear deterrent and the wider abilities to monitor the GIUK gap. We need maritime capabilities, combat air capabilities and broader logistics enablers, such as helicopters and all the other equipment.
It is really about trying to strike the right balance because what we are seeing is that, yes, while Russia is prosecuting a brutal war in Ukraine, using a lot of autonomy and a lot of attacks on civilian infrastructure, at the very same time, it is also investing very heavily into much more traditional production lines for munitions, naval capabilities and submarine capabilities. In fact, RAND recently published a commentary outlining some of the really long-term investments that it is making. Not everything that it is producing is going to go into Ukraine.
Q53 Chris Coghlan: Ms Retter, I just want to come in quickly on the procurement point. If you look at business management theory, it is almost impossible to change an existing organisational culture substantially, which is why you see start-ups succeeding against incumbents over the long run. A classic case study is Blockbuster versus Netflix. Blockbuster adopted its own video streaming service, but it did not know how to use it independently from DVDs and ultimately went bust. Netflix destroyed it.
If you apply that to the MOD, you can make the case that the organisational culture for MOD procurement is utterly broken and you would be better off starting it again or giving it to another department, such as the Treasury or the Department for Transport. I say that as an Army reservist officer.
Lucia Retter: I testified in front of the Defence Committee when it was writing its report on defence procurement, which then led to some of the defence reform and the integrated procurement model.
I would argue that there are pockets of good practice. Again, we should look at what they look like and how to scale them up. Operation Scorpius is providing equipment to Ukraine. There are various urgent operational requirements. How those are handled is very instructive. You cannot transplant lessons exactly one for one, but we can learn from the attitudes, mindsets and approaches that have enabled really speedy procurement when it was needed, which is why I keep saying that I am hoping that this time around the external pressures are such that the reform can meaningfully take hold.
People might be less optimistic because they have seen 45, 50 or 60 years of challenges in procurement, but there are pockets of good practice and we should not forget them. We should look at where they work and how they work, and scale them up.
Q54 Jim Dickson: Just to quickly pick up that issue, if you look across the Departments at which ones are reasonably successful at procuring on time, on budget and with successful delivery, the MOD seems very low. Is there something inherent about the way the MOD goes about this, to pick up Chris’s issue, or is it more to do with technological change and the complexity of some of the contracts that the MOD has to deal with in the type of stuff that it is procuring?
Lucia Retter: You answered your question somewhat, in the sense that there are all these factors that play a role. Yes, we are looking, particularly at the top end, at some very complex, very technologically advanced and technologically uncertain systems. We forget how much risk is often embedded particularly in programmes where the UK wants to develop something indigenously and invest in the R&D and the development.
These are very difficult, complex programmes. I am sure there are other Departments that struggle to run their big capital investment programmes on time, maybe transport or others, but there are certainly different flavours, and perhaps one of them is unique to defence. There is quite a high rotation of personnel in defence, unlike other Departments, particularly in the military staff, with a two-year rotation period, which I assume does undermine the longevity and learning, and the ability to really oversee the programme. Reforming some of the longevity in post type of restrictions, or being able to at least retain the institutional memory a bit better, would help, because that very fast rotation is a unique factor in the MOD, which we do not see in the other Departments.
Chair: Mr Kinniburgh, do you want to come in?
Andrew Kinniburgh: Yes, I would love to. We do have uniquely complex systems, and the other thing is the safety criticality of it. You do not want a weapons system blowing up in your face or misfiring when you are on the battlefield, so the standard of testing and of quality assurance is that much higher than something perhaps more mundane. Then, when you combine it on a very large platform that is going through state 7 seas in a monsoon, or minus 25° in the Arctic sea, you then have very complex systems and very sensitive scientific instruments operating at the very extremes of physics, really, so it is uniquely complex.
What is interesting, though, is where we see technology filtering through. Take the Apache attack helicopter. There is a programme that is looking at loyal wingmen—or loyal wing persons; I am not sure how to describe that—where you have drones that are, effectively, flying alongside and supporting that helicopter. The technology now, with AI and other capabilities, is probably going to make those autonomous systems relatively easy to retrofit to that helicopter. A lot of the intelligence will just be in a small box and in the helmet, and the pilot will be controlling those drones relatively easily, whereas, in the olden days, you would have probably had loads of sensors and avionics to load on to that helicopter and then integrate all of them. It is very complex and a very rugged environment, but perhaps technology will help us to reduce that burden over time.
Q55 John Glen: I want to just probe a bit more on this Treasury-MOD relationship. I was, briefly, for 13 months, Chief Secretary to the Treasury, and one of my Ministry of Defence ministerial colleagues said, “Your job is just to sign it off, Mr Beancounter. Don’t you get in the way.” I respectfully disagreed with him, as nominally controlling public finances, which was and remains the function of Chief Secretaries, is not straightforward. When we come to the dynamic between the MOD and Treasury, is there anything that works well and, if not, how can things be improved?
Mr Kinniburgh, you just set out, quite reasonably, the unique aspects of defence spending, but how do you convince the Treasury that this is not just a perpetual mechanism to avoid accountability for agreed budgets for admittedly complex capabilities at the start of which you would not know what they were? How do you avoid this impasse, which seems to have bedevilled an agreement coming through on the DIP and, indeed, on the journey to 3.5%?
Andrew Kinniburgh: The way I would characterise it is that there is a lack of trust between the two Departments, and that is a serious problem. I would like to see the Treasury stepping up a bit more and saying, “We are going to support you, MOD, and we are going to help you,” perhaps embedding more capability from the Treasury into the MOD.
As for the idea of removing procurement from the MOD, we talk about corporate memory in MOD not being very good for lots of reasons, including people moving on and that kind of thing, but recreating it somewhere else would be pretty scary. We would like to see Treasury being more supportive of MOD and learning lessons from things such as Ukraine and the urgent capability requirements that come through very quickly.
Q56 John Glen: On 1 September 2024, the Government, reasonably sensibly, asked Jean-Christophe Gray, a former director of public spending at the Treasury, to join the SDR team, presumably to give some validation of the plans and the capabilities, as a reasonable proxy for the Treasury’s eyes. What happened to get to a point where that has not then led to a smooth journey to the expected subsequent DIP and profile of spending being published?
Andrew Kinniburgh: It is a good question. I could speculate. It might be that the programmes that are already and have been running for many years continue to be late and over budget. Perhaps that has exacerbated the new Government coming in, looking over the numbers and thinking, “They have still not learned their lesson in MOD.”
Q57 John Glen: Yes, but the view is that, essentially, the Treasury is probably reluctant to give a meaningful uplift because it has not really reconciled, to a reasonable level of satisfaction, what gaps have existed in commitments already given and, apparently, spent. Is that a reasonable assertion as to why we may have this impasse?
Andrew Kinniburgh: Your sister organisation, the Defence Select Committee, did a report into the Ajax tracked vehicle programme, which is an incredibly complex piece of equipment. There were many problems, but the lesson to be learned from that is, basically, a blueprint for how to do it better in many cases. It looks at things such as senior reporting officers and a much more predictable management team that owns the programme right the way through.
Q58 Chair: There have been many reports from the National Audit Office and the Public Accounts Committee. If we were all paid by volume of reports about those sorts of things, we could dine out on that. Similar recommendations have been made many times, and yet we still see the same problem and the same gap in the defence equipment plan, more or less. It has gone up, in fact, as Ms Retter said, by £2 billion over 10 years.
Andrew Kinniburgh: We are back to Mr Coghlan’s point about culture. It is about how you take those lessons and embed them into the culture of MOD and the way it works, and that corporate memory and the churn of people.
Q59 Chair: Is there a problem with accountability?
Andrew Kinniburgh: Yes, absolutely.
Q60 Chair: Failure is always an orphan, is it not?
Andrew Kinniburgh: Yes, I think so, and seeing some people maybe losing their job because they have not delivered.
Q61 John Glen: Could you give us an industry view of what effect this has? The example that was put before us is the £1 billion contract for a new fleet of Leonardo helicopters that went very much to the wire. My expectation from the little bit of exposure I had was that Treasury tends to lock down as a bargaining chip until things are resolved. Then, essentially, the political pressure rises to the point that they concede on a particular project. What does that mean for your members and industry looking in at this process? What are the downsides of that, if there are any?
Andrew Kinniburgh: Leonardo in Yeovil is a great example. There is no larger employer for tens of miles around there. These are very high quality engineering jobs that just do not exist elsewhere. I have a couple of other examples of our members that are in Devon and Cornwall. There are lots of companies around there, but not at that level of 3,000 jobs. It took us and many others presenting the stark reality to the Treasury: “You do know that on Monday, when this offer expires with the MOD, there will be several thousand people with notices on their desk saying, ‘You are at risk of redundancy’?” That was the reality of it. It was only when we saw that that the Treasury stepped up and said, “Okay, we get that,” but it was an argument that was made for at least 12 months and probably two or three years before that.
Q62 John Glen: It does not give the impression that there is a co-ordinated plan that is made under controlled circumstances. It feels like it is very uncertain for industry. Is that a reasonable conclusion that we should draw from that?
Andrew Kinniburgh: Yes, it is. I have spoken to quite a number of chief executives over the last couple of days in preparation for this, and they all really say the same thing. They need predictability—knowing whether, if they have done a good job and put a compelling proposal into the MOD, that leads to any work.
Q63 John Glen: Mr Warner, could I just come to you about the issue of defence spending and equipment, what the fiscal rules do to encourage capital expenditure, and how that works? There is a sense that distribution of defence spending will be affected by fiscal rules, not rational decisions around capability. How should we think about this?
Max Warner: Perhaps a stylised fact to start us off is that, throughout the 2000s and 2010s, the MOD spent about 25% of its budget on investment and about 75% on day-to-day spending. Since about 2019, we have seen a big shift towards investment spending. Most new money has been investment spending, and we are now on track to be over 40% investment spending in the MOD, so we have seen a big shift. A lot of that could reflect the reality of what we want to spend money on, but as you have alluded to, the fiscal rules do give more space for investment spending relative to day-to-day spending.
A lot of investment spending is defence spending, and there is more space. There is not infinite space, but, in the world we are in at the moment, where the current budget rule is the primary rule that binds, that does mean there is additional space for investment spending over day-to-day spending.
Q64 John Glen: How does that relate to this whole issue of what capabilities we need? We talk about the size of personnel pools in the different armed forces and the capability. Are you saying that, because of that provision on capital expenditure and equipment expenditure, decisions will be made differently? What is driving what here? That is what I am asking.
Max Warner: From the outside, it is very hard to tell. There is probably a bit of both, but, as I say, from the outside, it is very hard to tell what is driving what.
Q65 Yuan Yang: Turning to international co-operation and procurement, there is an alphabet soup of options available to the UK that are happening elsewhere in the world. There is Security Action for Europe, or SAFE, which the UK has had difficulty negotiating to join. There is the Defence, Security and Resilience Bank, headquartered in Canada, which there are currently no plans for the UK to join. Then, of course, there is the Finland, Netherlands and UK multilateral defence mechanism. Ms Retter, looking at all these options on the table, what do you see as the benefits of the UK’s approach, and what more could the UK do with its partners?
Lucia Retter: The ones that you have outlined are on top of what already exists. There are already many mechanisms out there through which the UK can conduct joint procurement, through organisations such as OCCAR. The UK already has many bilateral and multilateral arrangements.
Without going into a deep analysis as to the merits and drawbacks of the Defence, Security and Resilience Bank or other forms, I would argue that it is important to make sure that whatever the UK participates in is something that can bring pretty quick benefits and can be set up pretty quickly. Speed should be a factor to consider in relation to what the UK commits to.
More generally, it is easier to collaborate with a small number of countries than with a large number of countries that have very different fiscal positions, capability requirements, plans and ambitions. If you are choosing to create a mechanism or a collaborative vehicle, it is probably easier to choose a smaller number of partners that are like-minded and perhaps looking to develop similar capabilities to what you need.
Q66 Chair: Do you have a preference between the MDM and the DSRB?
Lucia Retter: The DSRB is probably going to take a lot longer to set up if it is to be truly multilateral and include the different NATO countries, as it is envisaged, whereas something smaller and perhaps involving two or three countries is more likely to get off the ground more quickly, because you can just get an agreement much more quickly.
Q67 Yuan Yang: Is there anything that you might want to add on the negotiations around SAFE and why the UK has not been able to enter that so far, from your perspective?
Lucia Retter: I do not know enough detail of exactly what the negotiations are. SAFE is one of those mechanisms that are very much designed to benefit particularly countries in the EU that are trying to recapitalise their industrial base. The countries that are likely to benefit the most are those that perhaps have a lower base of industrial readiness right now. Of course, it is the way in which the UK can or cannot negotiate the deal that it wants to accept.
Q68 Chair: Mr Kinniburgh, did you want to add anything there?
Andrew Kinniburgh: May I give you our view from Make UK Defence? We would love to be part of SAFE. It is really important that we are part of the wider EU deal. We also need to be part of the $90 billion that the EU is lending to Ukraine, because the UK provides 25% of the industrial capability in defence in Europe. We are huge in those terms.
We really like the DSRB. I am not a banking expert, but we certainly see that as a really flexible, good way of raising capital at AAA-rated ratings that we can no longer do in the UK. The MDM also sits comfortably alongside that. They can co-exist. Where we get really nervous is the MDM’s procurement capability, which will take years to set up. Why do that when you have an OCCAR or a NATO capability that can procure multinationally anyway?
There are organisations such as MBDA, the missile-making company, which has four or five bases across several European countries, including the UK, and specialisms within each of those countries, so we look at multinational development as well.
DSRB and MDM can co-exist quite comfortably, but we really do not like the MDM’s capability to procure, because it will take probably a decade to get going.
Q69 Chair: I am not sure there is a difference there between Ms Retter and Mr Kinniburgh about the length of time it takes. You are saying DSRB would take a long while, but Mr Kinniburgh is saying that, because of the procurement side of MDM, that could take a long time. Which is the faster vehicle for investment?
Lucia Retter: There is so little detail on the MDM to go on that it is very difficult to understand exactly what it would and would not do. In general, I would argue that setting up these multinational-type organisations, when you have many more parties involved, takes a long time to negotiate and to agree exactly what the framework, the governance and the arrangements would be.
In particular, I would worry about what we often see in defence, which is this juste retour principle of how much the countries expect to get back, depending on how much they contribute to the mechanism or the organisation. Again, you can imagine a fair amount of negotiation going back and forth around agreeing who wants what back from the mechanism. My only point was about the speed and looking at what is going to give us faster access, really.
Andrew Kinniburgh: I just heard this morning, on pretty good authority, that if you are not part of the DSRB, you will not be considered as one of the equipment suppliers on funded programmes through the DSRB. That is news to me. I did not know that until this morning.
Q70 Chair: What is the source of that? That is quite important news.
Andrew Kinniburgh: I probably cannot share that with you, unfortunately.
Q71 Chair: Is there any way you can tell us that? You are telling us here that you heard it this morning. I just wondered whether you are absolutely, solidly sure about that.
Andrew Kinniburgh: If I may, I will confirm in writing.
Q72 Chair: That would be very helpful because that is quite big news.
Andrew Kinniburgh: It is big news. Our capability to export defence equipment is enormous. We have great capacity, so we need to be careful that we do not miss out.
Q73 Yuan Yang: Ms Retter, you mentioned that the devil is in the details for the multilateral defence mechanism. Given that we will have Treasury Ministers coming to this Committee to answer our questions about defence spending, what are the most important details to iron out and what would you like to see from the MDM?
Lucia Retter: With any of these mechanisms, you want to have a good understanding of the purpose and the desired outcome. From what I have seen in terms of the MDM, there is not as much detail around exactly what it is supposed to achieve. Is it increasing production readiness? Is it investing in SMEs? What is the primary purpose for which this is being set up? Being really clear on what that is and having that buy-in from the other parties is important. Maybe DSRB is the vehicle where that agreement is already there, in which case you can find that perhaps the negotiation does not take quite as long if there is buy-in to that.
Certainly, it is about having a clear understanding of what we are trying to achieve, what the desired outcome is, and what we are and are not doing, rather than trying to cover off all the bases and doing everything. To the point that Andrew raised around lumping in both financing and procurement, those are two different things and are, again, potentially risky to try to lump together into a common mechanism.
Q74 Chair: Mr Kinniburgh, we touched at the beginning on the investment and the lines of credit available to some of your members in particular. Is there anything you wanted to add about access to finance that you did not cover in those opening questions?
Andrew Kinniburgh: We have said to MOD that we need to be careful not to be seduced by venture capital-led companies. I probably will not name them because I will get into trouble, but they are the big American tech companies.
Dame Siobhain McDonagh: You can say all that sort of stuff here.
Chair: People know what you mean. It is all right.
Andrew Kinniburgh: Typically, they are the big American tech companies that go for funding, raise half a billion dollars, and come swinging into a market such as the UK and spend a lot of money on a range of technologies. Particularly for SMEs, which do not have that kind of capital to dip into, it is really challenging. MOD needs to be careful not to be seduced by the shiny new toys and getting the R&D done on the cheap. There is a balance there, so we need to be careful on the venture capital funding. Clearly, it plays a big part.
Q75 Chair: Would SMEs find it easier to get that finance if there was a solid, steady order book?
Andrew Kinniburgh: Yes, undoubtedly. It is interesting. We are doing some analysis at the moment and trying to help the MOD define exactly what a UK business is. There are some quite glib statements from MOD about 80% of contracts being let with UK-based businesses. What is a UK-based business? Is it one with a postcode and a company number, or is it a company that is creating intellectual property, registering patents, and making stuff using the supply chain in the UK? That is a question that you might want to ask the MOD. More surety of demand would undoubtedly release more funds.
There are lots of smaller companies in the UK being snapped up by German and American companies. There are a lot of regions in the US also saying, “Come over here. The water’s lovely. Come on in. It is great. We will help you with everything.” There are very well-funded counties in Washington DC and that kind of thing that are saying, “The market is much bigger over here. Come over here”.
Chair: There is a risk of not just a brain drain, but a company drain.
Andrew Kinniburgh: Yes, indeed.
Q76 John Grady: Can I just pick up on that? One of the things I used to do in a previous life was advising on the National Security and Investment Act. The basic idea behind it is that we need to keep IP and brains in the UK. I have in my seat Strathclyde University, which is a brilliant technological university, and Glasgow’s just across the road. They have a huge number of start-ups and smaller companies, for example, in the space sector. Just to get to the heart of the problem, they cannot get finance, and they are demonstrably British and Scottish, just like me.
Andrew Kinniburgh: And me.
John Grady: And you. They are demonstrably British and Scottish. They want to stay here, but they cannot get finance, because, to get finance, you need to show you have some customers and a prospect of having customers in the future. That is the basis on which people invest. People focus on things such as the National Wealth Fund, but is there not a cohort of companies in the UK that the MOD should be placing orders with and playing with, because it is dual use and they need to get on with it?
The risk you have described is quite simple. These companies are comprised of IP and people. If we do not foster and keep them here, they will go elsewhere, which creates a security risk and an economic growth risk. Sorry, Dame Meg, that is a question.
Chair: Do you agree?
John Grady: Would you agree with that? Have I got the point?
Andrew Kinniburgh: I do. You have got the point exactly. That little welding company I described that is helping a large company in the submarine world is supported by Strathclyde University. It is a great example of where academia bleeds into commerce, and it is a great combination.
There are a number of areas that the MOD is really good at. The Defence and Security Accelerator, or DASA, does exactly that, with early technology readiness level investment, but it is very small. That is the problem. Because it is such a small fund, it tinkers around the edges and it awards maybe 200 or 300 contracts a year. It might be between £250,000 and £500,000, so it is very small.
Then we talk about the valley of death, which I am sure you have probably come across, where you have early-stage funding and a technology readiness level, and then a yawning chasm of how you get from there to supplying volume or capability. We do need to think about MOD and, if it does get its bigger budget, how it can invest more wisely in those early-stage businesses and then try to bridge that valley of death so that it is not just snapped up by a big American company, or private equity coming in, snapping it up and submerging it into a group of companies.
Q77 Chair: So you are saying that, basically, there is more to be done to foster these defence start-ups.
Andrew Kinniburgh: I think so. More money spent up front with the early entrepreneurs, scientists and innovators will pay dividends for us.
Q78 Chair: Would there need to be some sort of golden handcuffs when you get set up and supported as a start-up? I represent Shoreditch, where a lot of tech businesses start up and then get snapped up by American companies when they get to a certain point. Is there any way of holding some of that so that we get the benefit for the UK taxpayer and for our own defence and security?
Andrew Kinniburgh: Yes, there is. It is going to cost money, unfortunately. That is the challenge. The procurement that the MOD is moving towards is the 3-2-1 model, where it will choose three really good companies that all demonstrate their equipment; it will then down select to two, and then to one. That is a much more SME and innovative entrepreneur-friendly process than previous ones, because you are maturing your product as you go through the procurement activity. It would be really interesting to see, and maybe there are other countries that do this really well to hang on to their really big brains.
Q79 Chair: I remember once visiting one of the carriers being built. They brought together multidisciplinary teams of private companies forced to work together, a bit like in the covid challenge, where people were forced to work together on ventilators, but forced to work in a particular way. They had to share a certain amount, which is quite challenging for those companies, but they got a very good way of delivering.
It was very expensive. I do not remember how many millions every day’s delay on the carrier cost, but it was a lot of money, so there was a real incentive for the SRO to keep things moving, but then there was no further supply of ships or boats beyond that, so those teams disappeared to all four corners of the world where they had come from. Very often, international expertise had been brought in. Is that an ongoing problem in defence where you just do not have that continuity of demand?
Andrew Kinniburgh: Yes, exactly. When it is lumpy, it is incredibly difficult to keep teams together.
Q80 Chair: Is there some argument for having something to bridge the gap? Although it costs money, it is cheaper than ramping up from nothing.
Andrew Kinniburgh: Yes, completely. If you want capacity and capability going forward for UK defence manufacturing, you need some sort of always-on capability. We have hundreds of SMEs that would absolutely love to have a couple of machines specifically ready to go if we need to go into high-volume manufacturing, and so we, undoubtedly, need to think about that.
Q81 Chair: How do you reconcile that, though, with competition? You want to have competition to help keep prices keen and make sure that there is an ability to benchmark versus trying to keep production moving without a gap.
Andrew Kinniburgh: It is not perfect, but there is quite an elegant example of that in Team Complex Weapons in the UK, which is a consortium. We have MBDA, which is already a multinational business anyway, as I have described. You also have organisations such as Saab and Thales, which are, ostensibly, direct competitors to MBDA, but they work together in Team Complex Weapons. You have the MOD co-ordinating things in the middle. I do not know it intimately, so I am sure it is not perfect, but it does provide a capability for the UK. It also recognises that we do not do everything in the UK. We need to collaborate. We need to be international as well as looking at UK production.
Q82 Chair: Finally from me on this, you represent big and small firms. You talked about venture capital before. What are the particular challenges? What would help? What are the differences between big and small firms in terms of finance? Where could taxpayers’ money be best used to make sure that we keep that diversity of supply ready to produce the capability that we need, whenever we need it?
Andrew Kinniburgh: I am probably a bit biased, but I would suggest SMEs need that support much more than the big companies. The big companies have the capital. They have the working capital to survive those lean periods. Perhaps a definition of a successful prime contractor is that it can bridge the gap between demand signals. SMEs are bleeding cash literally every single month.
Chair: On staff costs and overheads.
Andrew Kinniburgh: Yes, and particularly staff costs, because they are trying to keep those big brains and those amazing hand skills. One of our members sews uniforms. They are incredibly skilled. They are called Samuel Brothers. They make the King’s uniforms and the Palace footmen’s uniforms, and that kind of thing. They were talking about hanging on to those people with hand skills when they do not have enough work from the MOD, and you cannot replicate those skills easily.
Q83 Chair: You cannot ramp them up again in future.
Andrew Kinniburgh: Yes, absolutely. That might be designing a missile or sewing a pair of trousers. I know that those are opposite ends of the scale, but the skills that you require are unique and difficult. If you lose them, you will really struggle to get them back.
Q84 Chair: Is there an argument for, as in America, paying companies to keep ready to convert their production lines to defence production?
Andrew Kinniburgh: We would very much argue that that does need to happen. If we genuinely want to provide an industrial deterrent to Russia and our other adversaries, we need to demonstrate that we can ramp up very quickly.
Q85 Chair: Should there be some penalty there? Let us say I ran a company and was being paid extra money by the MOD to be ready to convert my production line at the moment of an international crisis, and then I failed to deliver. Would there have to be some severe penalty to make sure that the system was not played?
Andrew Kinniburgh: Yes, or certainly some pretty severe scrutiny, definitely.
Chair: We could go into so much on that.
Chris Coghlan: Mr Warner, you were making me quite depressed earlier.
Max Warner: Apologies.
Chair: Mr Coghlan is one of our happier members.
Q86 Chris Coghlan: Either I spend £500 more on defence personally through my taxes, or we destroy the welfare budget. Dr Paolo Surico testified to this Committee: “Historically, for the UK and the US, more than 80% of that increased borrowing due to the defence budget has been paid back by higher economic growth, not higher taxes or higher inflation in the future”. Are you being too pessimistic about our economic ability to increase defence spending and growth?
Max Warner: I do not know the details of that analysis, but it is a fair question. If you can get lots of growth by increased government spending, does that solve everything? Then the key question is whether we should expect lots of growth from higher defence spending. The answer is that we might expect some growth, but it looks unlikely to me that we are going to get a lot of growth and pay it back.
We should think about government spending in general first. Any increase in government spending in the short run could increase growth if there is slack in the economy and you could take it up. In the long run, if you can increase the productive potential of the UK through more capital, better skills and more productivity, you can increase growth.
Crucially, though, it depends on how it is financed. If we are raising taxes to pay for defence spending, or if we are cutting spending elsewhere, those will have growth effects too in terms of what it offsets. There might be some special parts of defence.
We have talked a little bit about R&D spending. There is plenty of empirical evidence that government defence R&D spending can have wider productivity benefits. It can encourage more private-sector investment. That would be good for growth, but the magnitudes there are not massive at the moment. UK government defence R&D spending is going up a lot, but defence is still quite a small part of government R&D spending and of total R&D spending. There are possibly positive effects, but they are unlikely to be large.
Q87 Chris Coghlan: Because the overall R&D spend, as you rightly say, is quite low.
Max Warner: Yes.
Q88 Chris Coghlan: The UK has been a complete economic mess since 2008, with low growth, a terrible fiscal position, and very low public and private levels of investment. Surely, we have a golden opportunity here to boost R&D overall and change that. South Korea, for example, has gone from being one of the poorest countries in the world in the 1950s to being the 13th largest economy in the world by having double the R&D spend that we have as a share of GDP. Does this defence issue we have right now give us an opportunity as a country to increase R&D?
Max Warner: It is an opportunity if the Government want to spend more on R&D spending, certainly. As I said, that can have positive growth effects, but we have to be careful of the magnitudes of what you might expect from that.
Q89 Chris Coghlan: In September, Draghi, the former head of the European Central Bank, urged the EU to borrow to invest in R&D. He stated that the growth would be higher than the interest rate on the debt. “By raising output faster than interest costs, such projects would gradually restore fiscal space and make broader investment needs easier to finance. The report estimated that even a modest 2% increase in total factor productivity over a decade could cut the public finance burden by one-third”. He is explicitly saying that the EU, by increasing R&D through borrowing to avoid the tax effects that you rightly highlight, is a very effective economic strategy towards growth. Would you agree?
Max Warner: I have not read that analysis in detail, so I will not comment directly on it. Again, there is possibility here. All else equal, it makes sense to try to do defence spending that will help growth, given that that is a big focus here, so having a focus on where we can get growth from this would be important.
Q90 Chris Coghlan: Given our economic position, is there a risk, of course, that the Government put too much emphasis on growth rather than defence needs?
Max Warner: Of course, the primary objective of defence spending is not growth. If a Government wanted to increase spending just to get more growth, you probably would not pick defence first. You would at least consider things such as transport and education as well. Positive spillovers on growth would be good, but you are right that there is a trade-off here between focusing on what defence needs the most and whether we can also get growth from that.
Lucia Retter: I definitely support what Max was saying. In fact, when we notice what other European countries are doing in terms of the public engagement or public communication as to why they are increasing their defence spending, they are not using the arguments around growth. In fact, I find that the UK is quite unique in how the public messaging is presented as being that this investment is to drive growth. The messaging that we are seeing in Germany, Poland, the Baltics and the Nordics is much more honest around the nature of the threat and the changes in the geopolitical environment, so there is a bit of a contrast here.
Again, if we do spend more money, we absolutely want to spend it well. We want to spend it in a way that generates growth and creates the skills, the regional opportunities, the IP, the R&D, the spillovers and all of those good things, but I would again caution around the primary purpose as to why we would be increasing defence spending.
Andrew Kinniburgh: I would agree that it is not the primary purpose, but, if you live in Yeovil, in Barrow-in-Furness, in Helensburgh, my hometown, near Faslane submarine base, or in Plymouth, there absolutely is growth from defence, and those economies would collapse overnight if we stopped spending on defence in those areas. I accept your argument, but it can be an engine for growth.
The biggest employer in the outer Hebrides is QinetiQ, on the ranges there. What we were arguing for is to get a flipping further education college in the outer Hebrides and start learning from that amazing, world-class range. If we used our imagination, it could drive much greater growth. I would ask those people in Barrow what they think of defence spending, and I think they would be clear.
Q91 Chris Coghlan: I entirely agree, and it would solve both our economic and our defence problems in one go. Mr Retter, to your earlier point on finance mechanisms, surely you have an opportunity here as well to issue debt at a higher credit rating than we can, particularly in defence, and fund this R&D rather than in other areas. Of course, things such as health R&D are fantastic, but that is more likely to scare the markets if it is not collateralised.
Lucia Retter: I am not an expert in the different financing mechanisms that you can use to raise capital. Certainly, we have seen a lot of defence R&D spillovers into the wider economy. You get the classic example of the Gripen in Sweden and the huge number of spillovers that we have seen. I would never dispute any of the economic benefits that do come, particularly in the deprived regions of the UK.
Again, defence is a great example in terms of bringing some of those regional benefits where there would just not be other jobs. There are entire economies depending on this. The question is different when you look at the macroeconomic picture that Max was outlining and how, at a really high level, if you look at a sectoral comparison, defence R&D spillovers compare with other sectors. That is a slightly different level of comparison.
Andrew Kinniburgh: May I make a pitch?
Chair: You do earn your money as a trade rep.
Andrew Kinniburgh: As the Treasury Committee, maybe you could ask the Treasury about this. We are working with Professor Paolo Surico.
Chair: You have a mutual admiration.
Andrew Kinniburgh: Yes, absolutely. He is a very clever guy. What he has identified—and we have really come in behind him on this—is the patent box money. At the moment, £1.8 billion is being given as, basically, tax-free allowances for intellectual property and patents, mainly to big pharma companies. We say, “Take that out of there and put it into defence: 1.8 billion quid, free money, bang, back of the net.”
Chris Coghlan: Right there for R&D.
Chair: Is it free money, Mr Kinniburgh?
Andrew Kinniburgh: It is probably not free money. The second one is defence innovation bonds. That comes back to the R&D spend and the idea of looking at things like we did in the second world war, where we had defence bonds and raised tens of billions of pounds in today’s money. If you were to raise money using those defence innovation bonds—innovation being the key, not just for buying bullets and shells, but investing in early-stage R&D and really driving that economy, like we spoke about earlier on—that could also have an enormous impact.
Chris Coghlan: I might have written to the Chancellor to suggest things such as that.
Andrew Kinniburgh: So have we.
Chair: Thank you all very much indeed. We have had a very interesting discussion about the gap between the UK’s defence goals and capabilities, which is something that our sister Committees have looked at as well; about the affordability of the plans and the strategic defence review, which we cannot make a full analysis of until we get the defence investment plan, or the DIP, as it has often been referred to during today’s session; and about the challenges affecting the defence industry that the slow publication of the defence investment plan has led to, as well as a lot of discussion about defence procurement.
We have no firm date yet for our next session, because we are still waiting for confirmation of attendance from the Chief Secretary to the Treasury and a Defence Minister. We will be doing that with our sister Committee, the Defence Select Committee. We really want to cut to the chase inside Government about what the plans are for funding defence, how that is going to work, how the Treasury will let the Ministry of Defence do what it does, and how the Ministry of Defence will justify its expenditure to the Treasury.
So thank you very much for your time, Andrew Kinniburgh, Lucia Retter and Max Warner. A transcript of this session will be available on the website, uncorrected, in the next couple of days, and we will make sure you get a copy of that. Thank you very much indeed.