Armed Forces Act (Continuation) Order 2017

Lord Davies of Stamford Excerpts

Tuesday 21st March 2017 Lords Chamber

[Lord Davies of Stamford (Lab)]

My Lords, it is a great pleasure, and not for the first time, to follow the noble Lord. He brings to this House a whole lifetime of experience both in business and in maritime affairs and defence. I very much agree with what he said.

I think the whole House is well aware that I was the Defence Procurement Minister in the last Labour Government, under Gordon Brown. In that role, I was often, and continue to be, accused of having overspent and having created, or culpably presided over, a procurement deficit of £30-odd billion—the actual figure varies from time to time. I have dealt with this matter in correspondence with the Minister and asked him to put that in the Library. I do not know whether he did so: I found that only members of the Government can place correspondence in the Library. Briefly, I could not possibly have overspent because the Treasury would not have allowed me to do so. What I never did, unlike the subsequent Government, was underspend. They did so on two occasions and a large amount of money was permanently lost to defence. I would have regarded such an action as a betrayal of the very important fiduciary responsibility which had been confided to me.

There is always a degree of uncertainty about the cost of a future programme, but the bulk of the procurement deficit was created, when the new Tory-led Government came to power, by the simple expedient of changing, from 1.5% in real terms to 0% in real terms, the rate of increase in defence expenditure, both currently and prospectively. Doing that, given compound interest and a defence budget of £35 billion, you can create a very large potential deficit and that is exactly what they did.

When he appointed me, Gordon Brown said that my first task was to make sure we got the right equipment out to Iraq and Afghanistan. We did that, and commissioned seven or eight new, bespoke armoured vehicle programmes. On one occasion, we actually got down to six months between specification and delivery to the theatre, which was an absolute record. Anybody familiar with defence procurement will realise what that means. It is a tremendous tribute to the ability, determination and morale of the people working in the DE&S—people who were subsequently, quite disgracefully, attacked publicly by the man who the incoming Tory-led Government put in charge of them. We also made some considerable breakthroughs in areas such as ground-penetrating radars, which were a vital part of the anti-IED programme.

I did not neglect in any sense the core programmes. When I arrived, I found that the two carriers were running into considerable cost overruns and delays. The Defence Board had decided that the programme should be extended by several years—at an enormous increase in cost, because you are doubling and trebling the fixed cost as each year goes by. It was obvious to me that, if that happened, we would ultimately end up cancelling the whole programme. I managed to persuade the Secretary of State—my noble friend Lord Hutton, who unfortunately is not in his place today—as well as others in the MoD and indeed in the Treasury, in due time, that we should go for a quite different option which had not been considered by the Defence Board. This was Option C, as the noble and gallant Lord, Lord Stirrup, may recall, which involved some delay and some additional cost, but of a relatively manageable kind. Fortunately, as a result, it was possible to save that vital programme.

On the Type 45, I thought they were wonderful ships and I still think so. I believe three were launched in my time; they were ordered long before I arrived. But I admit to the House that I never asked—it never occurred to me to ask—the brilliant naval engineers, admirals, shipbuilders and ships’ architects that I was meeting on that programme the key question: are you quite sure you specified enough power to run both the propulsion system and the radars at the same time? I have no idea how such experienced people would have reacted to a Minister asking a question of that type. However, I say with culpability that I should have asked it. It was a pertinent question. I still want to know what happened, and I think the public need to know what happened. There should be a public inquiry about it. I would look forward to taking a full part in such an inquiry to get to the truth.

The other great naval programme was Astute, which I shall come to.

On the RAF, I found when I arrived that the MoD was attempting to push forward as far as possible, in order to save money, the purchase of tranche 3 of the Typhoon. We managed to turn that one round, and I managed to negotiate with our partners for the tranche 3 programme to move forward. I am glad it has done so, because that aircraft now provides the cutting edge for our air capability in the period between the retirement of the Tornado and the arrival of the F35. It will continue—with the Meteor missile—to be the key power we have in the air-to-air area, prospectively into the 2030s.

I was also keen that we get into the unmanned aircraft business. I brought the French into that, because it was important to have partners to share the cost and, particularly, to secure longer production-runs than would have been possible if things were run purely on a UK basis. In addition, we had to renegotiate the A400M programme. I believe we did so successfully. I am a great believer in that aircraft—I think it will be the Hercules of the 21st century—though at times it too looked under threat.

With Nimrod, I inherited something that has now gone down in business schools as a classic example of how not to procure a military project. At the time I arrived, as I recall, the cost was around £2.3 billion for four aircraft. But I believed then, as I believe now, that economic decisions should be taken on the basis of marginal cost, not sunk cost. It was clear to me that almost all the capital cost had already been incurred—certainly, by the time of the election, all the capital cost had been incurred. Therefore, I looked open-mindedly at whether we should stay with that, or buy the P3, which was another possibility in those days. I became convinced that the right thing to do in those circumstances was to stay with the Nimrod programme. Had the Government done so—compared with what they are now doing in buying the P9—I believe they would have saved a lot of money. What is more, we would not have this irresponsible gap in our long-range maritime surveillance capability which we have been running now for many years, and which is quite frightening.

From these experiences, I am left with one or two conclusions, which I want to share with the House. One is that an awful lot of nonsense is talked about how defence procurement would be much more efficient if it were based on fixed-price contracts and if competition were involved. In most cases, you cannot do either of those things in defence procurement in our country because we have to operate at the frontiers of technology. We can send our brave young men and women to risk their lives only if we provide them with the very best equipment that money will buy. That means investing in new technologies, and you cannot speculate in advance what the costs or problems will be.

Every first of class is a prototype. If it costs £1 billion, like an Astute-class submarine, you cannot throw it away, saying, “It was a prototype; we’ll start again”, but it is still a prototype. You are going to spend an awful lot of money at the beginning of these programmes and you cannot tell what the costs will be. If you force the contractors to accept a fixed price, as happened with BAES over Astute and Nimrod, they will just blackmail you after a few years, saying, “We can go bankrupt if you want but we can’t come up with £5 billion”, or whatever it costs to change the programme, so you have to renegotiate, as we did on those occasions. However, that is the worst of all possible worlds.

The solution to that problem is the one that we devised in the case of Astute—that is, to have a target price with a reward for the contractor if it comes in under it and a penalty if it comes in over it. The whole thing was kept under very close and constant review, and that worked for the rest of the Astute programme. I think that that has a very wide application in defence.

Secondly, it is very important to have partners in this business, not just to share the costs of R&D, which are enormous, but because the economies of scale in production runs are so important. We tend to buy both systems and programmes a few dozen or perhaps a few hundred at a time, depending on what we are dealing with. In the same area, the Americans will purchase by the thousands or tens of thousands, which makes the economics completely different. We can achieve something in that direction only if we have partners, not just to share the R&D but to make sure that we have much longer production runs. I did that successfully with the French on several occasions, and it is something that we need to do more and more.

Incidentally, I am delighted to see that OCCAR—an organisation that I strongly supported in every way that I could at the time—has been a great success. I think that it is now running about 30 joint European programmes, including the A400M. It is under the charge of one of my ablest civil servants, Tim Rowntree, and it has been a delight to see how successful that whole project has been.

Another thing that I want to share with the House is that there are a lot of illusions about exportability. I think that it was General O’Donoghue and I who first laid down that exportability must be considered at the specification stage and reported on at the “initial gate” stage. I am very much in favour of it and I commend the Government for trying to do what they can to achieve some exportability for the Type 26. However, again, because we need the best in this country, we will always tend to overspecify. Therefore, in practice the opportunities for export will be really quite small, and we have to face that uncomfortable fact. That may be the case with the Type 26. If it is not, and even if we export some variants of that frigate, we may well find that there are diseconomies of scale by virtue of the fact that we have split up that programme.

Finally, we must go over to modern accounting principles, particularly present value accounting, in defence procurement. I could have saved a large amount of money—perhaps £300 million or £400 million—by purchasing all the supplies and components that we needed for boats 3 to 7 of the Astute programme at one go in bulk, but that was impossible because the Treasury would not let me bring forward the purchases in relation to subsequent parts of the programme, even if I paid it back, as it were, with a substantial discount rate, which of course I was prepared to do, representing the costs of the capital involved. In the private sector, you would always make investment and purchasing appraisal decisions on a present value basis, but we cannot do that in the public sector.

Another good example was the MARS programme for naval tankers. I wanted to take advantage, opportunistically, of the collapse in the shipbuilding market after the Lehman Brothers disaster and so forth and buy in the market, for about $50 million each, tankers that were in the programme at £200 million. Even with the discount rate, the Treasury would not let me do it. By the time of the election, I persuaded not only my own finance director but the head of the National Audit Office, Sir Amyas Morse, to move in that direction, and I was in the process of persuading the Treasury to do so. I set out to my successor the importance of doing this and I thought that I had persuaded him as well. Sadly, I do not think that any progress on that has been made but I raise it this afternoon in the hope that that matter too will be looked at again.