Is the Norwegian defence sector compensated for general price growth?

FFI-Report 2024
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Sjur Aarthun Hodnesdal Even Soltvedt Hvinden
We analyze whether the defence sector is compensated sufficiently for increased costs due to general increases in input prices. Based on this, we recommend an additional one-time compen-sation as well as the development of a separate price index for the defence sector’s inputs. The increase in consumer prices (CPI) between 2021 and 2023 exceeds the defense sector’s price compensation (FI-M) by approximately 4,6 percent. To restore the defence budget’s real purchasing power, the defence sector must be compensated by approximately 4,6 percent in addition to future price increases. If future budgets are not compensated beyond future price increases, the prior insufficient compensation will permanently reduce the real value of the defence budget. To estimate the decreased real level of the defence budget we evaluate expenses for materiel and property, buildings and facilities for 2021–2024, and future projections for 2025–2042. We assume that the growth in FI-M equals the growth in CPI from 2024 (full compensation for general price growth after 2023) and that only investment projects affected by future price increases need to be included, permitting exclusion of compensation for currency effects, acquisitions under contract and price-adjustments of investments in large property, buildings and facilities. We estimate that the insufficiently compensated price increase between 2021 and 2023 reduced the real value of the defence budget by NOK 2,5 billion (2023-kroner) in total. Going forward, the under-compensation reduces the purchasing power by 1,6–2,4 billion 2023-kroner annually between 2024 and 2042. The analysis highlights how a time-limited insufficient compensation can nonetheless lead to a permanent real reduction of the defense budget. In calculating the insufficient price compensation, we assume that CPI have been and will be an accurate measure of price growth in the defence sector. However, if the price increase of defence goods and services exceeds the price growth in the general economy, the purchasing power will be further reduced compared to what we have calculated. To evaluate whether CPI serves well as a measure of price increases in the defence sector, we compare price developments and market expectations for the general economy and the defence sector internationally.U.S. producer price indices for the whole U.S economy and U.S federal defence spending show a strong correlation between 2018 and 2023. The coinciding price development of the defence sector and the general economy suggests common causes for the price increase. However, NATO-reports, stock market developments and projections by Jane’s Information Group suggest expectations of larger demand in the defence sector compared to the general economy in the future. Given these observations, we consider the CPI growth as a lower bound of future price growth in the defence sector. Thus, the real reduction of future defence budgets may exceed our calculations. Compensation for increased prices should match the actual price development, for example through adjustments prior to year-end. We recommend developing a separate price index for the defence sector’s inputs to ensure correct compensation of increased prices.

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