Defence specific inflation

Authors:

  • Peter Nordlund
  • Peter Bäckström
  • Bernt Öström

Publish date: 2016-06-27

Report number: FOI-R--4277--SE

Pages: 66

Written in: Swedish

Keywords:

  • Defence specific inflation
  • defence inflation
  • cost escalation
  • defence price index.

Abstract

The project "Defence specific inflation" is one of the projects within the Swedish Defence Research Agency´s (FOI) activities on scanning the status of a range of research topics. The scanning has partly been done through a literature inventory of theory and empirical evidence relevant to the assessment of defence specific inflation and partly as a study of various international applications to measure the defence specific inflation. We have identified six countries, except Sweden, that in different ways tries to estimate the changes in price and wage levels within the defence sector: US, UK, Canada, Australia, Finland and Israel. The literature points to two main challenges when it comes to price and productivity measurements within the defence sector: difficulties to define the production of defence in a way that allows measurement and combining the width of the output to a single measurement. Difficulties to measure what it costs to produce the defence output, with a standardized measure per "unit" of the product "defence" means that none of the countries have based their indices on the defense "output" in the form of defense capabilities, defense power, utility, etc. All the studied countries with some form of price indices estimating defence inflation have instead defined inflation as priced changes of different inputs to the production of defence. It is the price trends for the different resources that are needed to produce a defence, such as military personnel, civilian personnel, armaments, equipment, fuel and other goods and services, which are measured in order to determine the defence specific inflation. The description of the indices that are used in the different countries focuses on the building and the construction of the indices, and how they are used. In the presentation of the indices we describe whether the indices are based on attempts to measure the actual price trends for the resources that the defence uses or if they are based on approximations where official indices, not defence specific indices (proxy-indices), are used to estimate the defence inflation. Another dimension has to do with the use of the indices in relation to decisions on the defence budget. We distinguish between a direct impact on the budget, meaning that the indices are used as a calculation formula to directly adjust the defence budget in order to compensate for defence inflation and an indirect impact where the indices are used for discussion and as an argument on the defense economy. Most of the countries we studied build their defence inflation estimates on different official proxy-indices, with the exception of UK and US who partly build their estimates on actual measurements of defence specific conditions such as salaries and contracts. Finland uses an official salary index where the defence sector is presented as a separate part, which gives a close fit to actual salaries within the Finnish defence sector. We have noted that the Swedish defence price index, particularly in its use, appear to be unique in comparison to the studied countries. This is mainly due to fact that the index directly affects the defence budget and that a deduction is made for expected productivity.