AG Strikes Again!
The spring report from our duly canonised national Oracle is out, and with no end of headaches for the incumbent government. As usual with these reports, what we are being treated to is the media spectacle of journalists and political parties like who, being unready (or unwilling) to transparently advocate substantive, alternative goals and priorities for Defence, are instead consumed with moralising the process problems, a way of fighting proxy battles that discredit opponants whose priorities are suspect. And in Canadian nationalist iconography, what could be more suspect than American fighter jets? In the field with the Army, a gaggle of human, recognizable, courteous and loveable bear-like “troops” makes for a plausible voter-friendly photo op; after all, so much of what the Army does resembles camping – and what true Canadian can resist camping? Thus a rural-rooted government would far prefer to busy itself equipping men than with manning equipment for the Navy or Air Force. In the case of boots on the ground in Afghanistan, the human narrative dominates and sentiment rules our policy; where high tech is the main effort, ‘sticker shock’ over the grotesque expense eclipses any human element, and puts the ‘bean counters’ in the centre ring spotlight. So it is for the question grabbing headlines over plans to buy the “F-35 Lightning II” Joint Strike Fighter (JSF)… and it’s just those kinds of process problems that concern paper-trails
Our verdict? The root of our problem is that price, cost, and value arenotsynonyms.
We’ve had a good class discussion on this, in the context of the switch to Accrual Accounting and public financial planning. Price describes a material transaction, and is thus a simple variable at a given point in time, whereas cost describes a systemic context, such as a market, in all its complexity across a wider economic landscape, and over time. A price is a datum, a piece of historic information, whereas cost is an estimate, a piece of integrated, holistic knowledge. I might sum up by saying that price is one dimensional, whereas we would have to calculate cost as at minimum four-dimensional, so to speak… and usually much more mutli-variable than that. As another bloggers commenter puts it:
It’s amazing how even supposedly sophisticated multinationals miss some of the fundamental elements in this post. I’ve worked for companies which insist on initiating pricing discussions based not on what the market will bear, but based on a “fully loaded cost” (including amortized fixed costs for general company overhead) grossed up to meet a minimum margin requirement.
It’s easy to see where that type of logic can lead. Depending on the price elasticity of the category/product, far fewer units may end up being sold at this “grossed up” price than the theoretically optimal market demand price. That can cause the company to allocate even GREATER fixed overhead per unit to the product and maybe even raise prices further to continue to meet the margin goals.
And pretty soon you’ve priced yourself out of business.
Obviously, one major cost over time is capital depreciation: the replacement cost of a product will be higher if inferior quality makes it likely to be incurred more frequently. How depreciation is estimated for maintenance costs in operations budgets, or financial costs against institutional capital liquidity (i.e. the option to liquidate, by resale) can all be highly subjective since it relies on quantifying inherently qualitative problems.
More tangibly, the price/cost distinction should be vivid in the economic concept of Opportunity Cost, wherein we note that any decision to act (e.g. to stay home raising children) carries the implicit cost of foregone opportunities for alternative action (e.g. working), so that even if we don’t have to pay these costs out-of-pocket (e.g. fee for a parenting licence) the disincentive ought to be equivalent, in principle.
In practice, we can observe prices much more easily than we can accurately estimate opportunity costs. Real human beings are prone to the cognitive heuristic of Loss Aversion. For example, a dollar fine for speeding over 100kph is, provided unbeatable radar cameras, a relatively effective disincentive. Whereas if we charged everyone a high toll and offered slow-driving rebates – such that drivers keeping under 100kph had their entire toll rebated – the gain would attract fewer speeders than the loss deters. All things being equal we’d rather save a dollar than earn one – roughly twice as much so. Applied to risk calculations, people appear to require in abstract roughly double in potential payoff to justify risking a given potential loss on any bet with fifty-fifty odds, with the resulting bias towards caution. Rationally, of course, all we should need is a mere sliver of margin for the payout over the cost of a loss, and the better would be gauranteed to accrue winnings over repeated games – just as conversely, when offering equitable payout/bust terms a mere 51% odds are good enough to make blackjack a winnable table game over the long run. Of course, casinos still win plenty on human error in calculating odds on each hand delt – which is why Loss Aversion obviously isn’t an arbitrary irrationality, so much the irrationality of modesty.
The ‘Precautionary Principle’ so popular (and unhelpful) in Environmental Law is an extension of this, resting on the uncritical assumption that inaction is safer than action. In climate change debates precaution cuts against enacting rational policy – at least, rational insofar as the scientific consensus is trustworthy – as illustrated by the frog analogy. But more often than not, inaction probably was safer than action for homo sapiens sapiens in our natural habitat, where we where a large, sense-gifted, dominant predator. ‘When in doubt don’t eat it’ is a pretty trusty cognitive heuristic as such rules-of-thumb go, and easy to explain from evolutionary psychology. (Especially if balanced by another of our well-documented cognitive heuristics, Social Proof, which creates a largely countervailing bias against inaction to favour action: if everybody else is doing it, best join in). In habitat where further observation will tend yield further usefull information, but threats and hazards which haven’t yet hurt us by surprise in the first place are not too likely to do so unprovoked, this kind of cognitive bias fits both our safest inferences into evolutionary history and observations of clinical behaviour. An economics of Loss Aversion is every bit as ‘rigorous’ as an economics of intricate efficiency models, predicated on a homo economicus of rational self-interest – more so! Real People are obviously not rational, and incentives that presume they are will be inefficient.
So how then do we reconcile the kind of consistent behaviour that our best and brightest Math Geeks can measure – that accountants are competent to record, that economists are competent to model – with the kind of behaviour that we actually see in the real world? Well, denial about the discrepancy won’t help. Since the 2008 crisis we’ve seen some degree of mea culpa from the economists, to the point that it’s clear from a variety of political perspectives that ‘behavioural economics’ has taken pride of place over the ‘rational choice’ economics invoked to justify deregulation – as least for those of us outside the discipline looking in. On the accountants’ side of the disaster, however, failure has largely been moralised, with the results that system fallacies build into accounting itself are not being scrutinised as they are (if too late, too late) for economics.
If our bureaucratic order has a mantra, it is this: The solution to accounting failures is always more accounting.
Nobody would question the mandate of the Auditor-General to verify the figures on a procurement deal like JSF to determine if the price implied by the contract is that which the Parliament has authorized. In general, that is what the laymen of the general public (including myself, until a few weeks ago) understand the profession of accounting qualified to do: search for errors or fraud in the arithematic of financial data. We assume accountants are people who count things… that’s why we ‘accountant’ is the shorthand cliche for a very boring job. In the era of the Audit Society, that’s not how accountants see it however – at least not anymore. The contemporary profession has been re-orienting itself to calculate the cost of things, or even better the value-for-money, which are much more challenging and thus more interesting (and lucrative!) lines of work. If a CFO is conceived as a cost control authority, for example, then the implications for capital costs to the balance sheet and opportunity costs to corporate strategy empower them far beyond the cash-control vigilence of a mere Treasurer. To monetise depreciation, for example, requires the value being depreciated; outputs of performance all over the organisation, relative to benchmarks from parallel audits written by peer accountants. Audits achieve a ‘mission creep’ far beyond the search for error and fraud, or even the search for consistency between stated procedures and real operations; audit become the medium for what Luhmann calls autopoeis – “The representation of the system within itself” – in the corporate context, and thus the locus of qualitative strategy.
So I do question the mandate auditors are actually claiming today. In business, if the CFO-Auditor dialectic is the corporation’s autopoeisis – its brain – isn’t the CEO-COO waltz is rendered a mere theatre of figureheads? By analogy from Bagehot’s governance functions of ‘the efficient’ and ‘the dignified’, could this power drift explain why MBA faculty grooming CEOs have become so seized with ‘leadership’ lately, and so dismissive of mere ‘administration’? It’s a mistake to assume all corporate officials seek to maximize material power: they seek to maximize prestige, and sometimes (frequently!) the two diverge. Making choices is hard, and the accountability attached to them is a personal liability. If the data interpretation that shapes decision-making towards fait accomplis can be mostly delegated by CEOs, in favour of their focus on the ‘soft skills’ of being as inspirationally prestigious as possible, the trend seems perfectly understandable. We would expect to see CEOs focus on this most aggressively in consumer sectors where the soft skills are built into the product – where design is king – and indeed we do:
Virgin Atlantic doesn’t sell airline tickets, they sell Richard Branson’s lifestyle. An entrepreneurial CEO with Branson’s charisma – his machismo, to be precise – is also paid for his conspicuously low Loss Aversion and consequent higher risk tolerance. Even where the cost calculations for his new ventures are uncertain he is able to make strategy by an appraisal of the likely value on the gain side. …No, especially with cost uncertainty! As cost is to price, value is to cost, or so I would suggest: value is benefit adjusting for incurred costs – that benefit is features another order of magnitude in complexity. Cui Bono? Value is a social configuration of scarcity from various perspectives of unique our identity: it’s qualitative. Value is different to different people; it’s cultural, even moral. At the expense of precision we can categorise values – we have to – but we have to use language to do so; numbers are a weak tool. Math is not a ‘universal language’; pure abstraction cannot express identity. So seeing as attempts to artificially quantify value can be so misleading – neglecting the old chestnut about the foolish miser knowing “the price of everything and the value of nothing” – an intuitive appraisal of what people value, including to which side of their irrationalities a product will fall, can work relatively well (provided your CEO has Richard Branson’s quality of intuition!) When the competition is dazzled by metrics, it is indeed categorical intuition for where the undetermined value lies that often prevails.
At BP, on the other hand, the nature of the business is a numbers game. It strikes me as hard to argue the CEO effectively controls of much of anything that accountants and actuaries reading geology haven’t already pre-calculated, pending his rubber-stamp.
As I’ve learned in my Financial Management class last autumn, this is exactly how Big Accounting likes it. Our guest speaker, from a Big-4 consultancy, made his entire presentation a plea for this empowerment: “Really I try to explain to people, when we come in it’s not just to talk numbers, it’s about performance.” I piped up to question whether there wasn’t some wisdom to the laymans’ definition of accounting – shouldn’t somebody be focus on the numbers? If accountants are specialized to that task, who is? – but that only drew a blank stare, so I resisted the temptation to disrupt the class with my cranky Michael Power references. Once you’ve outsourced contemplation, decision-making is sure to follow, and the recent push to have Big-4 auditors abstain from selling strategic advice on conflict-of-interest grounds, while positive, obliviously fails to confront the systemic reason why that service is such natural fit in the first place.
Considering this price/cost/value distinction in light of corporate organisation for division of labour is an excellent example of something unexpected I’ve discovered here in Wellington: that I’m really quite interested in accounting… (!?) What accountants actually spend their time doing is increasingly an endeavour in categorisation rather than arithmetic. That’s why they’re in the process of accruing so much administrative power in our society – at the expense of other, more traditional categorises like lawyers and jurists, who’ve drifted into the sphere of constitutional moralising (a function vacated by state theologians, I suppose). Unlike treasuries, estimates are uncertain and thus subjective, and subjective expertise is where the discretion and thus power lies in a bureaucracy. Contemporary practices in deprecation and accrual reporting record costs and transfers of value from the date they are planned to transpire, not necessarily when cash changes hands. This makes estimate and predictive analytics core to their work: not too problematic for Wilsonian ‘Production’ organisations where material outputs and outcomes for goods can be clearly measured, and thus extrapolated forward, but quite problematic where, for either or both, measurement and quantification for monetization are at best indirect if not wholly invalid. Service sectors generally and public services especially are notoriously immune to the advice of accountants and economists.
So. Against the cost of an F-35, how do you quantify, let alone, monetize the value of security? How do you estimate the cost of future wars that haven’t happened yet?
What is the cost of the risk of some future Pearl Harbour or 9/11 to an unprepared North America – or of Canada’s inability to participate in some future Libya-like air power intervention? What is the value?
Or use a spot-on example: what, with benefit of twenty-twenty hindsight to historic events, would the value of the Avro Arrow program have been if complete and delivered? What would the cost have been? In the report in question, the AG is doing what accountants have been doing lately: going beyond price of an aircraft to estimate holistic cost of the function it will perform. Since the CF-35, like the CF18 before it, will effectively signify the entirety of Canada’s combat airpower, this amounts to estimated the cost of running and Air Force. So it must be asked – is this a reasonable scale of prediction to undertake? Even after fifty years Canadians with ample expertise and all the historic data at their disposal will give you completely contradictory views of its total worth. So for heavens’ sake (sic), why would the Public Works venture such a guestimate as a accountable prediction in advance?
“We have a number of observations regarding the life-cycle costing for the F-35. First, costs have not been fully presented in relation to the life of the aircraft. The estimated life expectancy of the F-35 is about 8,000 flying hours, or about 36 years based on predicted usage. National Defence plans to operate the fleet for at least that long. It is able to estimate costs over 36 years. We recognize that long-term estimates are highly sensitive to assumptions about future costs as well as to currency exchange rates. However, in presenting costs to government decision makers and to Parliament, National Defence estimated life-cycle costs over 20 years. This practice understates operating, personnel, and sustainment costs, as well as some capital costs, because the time period is shorter than the aircraft’s estimated life expectancy. The JSF Program Office provided National Defence with projected sustainment costs over 36 years.”
That such projections are available proves only their vaunted military-industrial complex is willing to play this game – not that it has any validity. That the AG perceives “exchange rates” as the most exemplary source of long run uncertainty in military materiel is laughable: our warriors ought to fear ‘the fog of Zurich’ I suppose? In fact, that’s perversely evocative of the truth: the story of Robert MacNamarra’s War in Vietnam is not the story of how war is inherently unneccessary, or how all counter-insurgency interventions are futile: it is precisely the story of the misapplication of managerialism; of tunnel vision and groupthink amid statistical noise; of quantification-begotten category error; of value-for-money incrementalism and the resulting mission-creep of looping strategic of feedback traps.
…Replacements, Upgrades, Weapons; all of the operational questions are completely unpredictable if the aircraft are ever used for their intended purpose, which is to fight World War III, and mostly unpredictable for the small wars the Allies have been fighting recently which all presume will be more likely. Salaries for crews? Seriously – operator salaries are part of the cost of the aircraft? Nonsense. Such salaries are fixed costs outside the procurement choice in front of us. There is no Opportunity Cost at stake because choosing not to operate an Air Force as part of a national defence means, in theory, the country’s destruction. Depreciation is most meaningful for military purposes relative to technological level of threats, which is either unknown or (quite properly) a state secret. The cost of total war is open-ended and uncontrollable; that is its nature.
To analyse costs value-for-money by ‘operational requirements’ is futile, therefore: we need to gage our spending by strategic requirements, i.e. the risk of total war transpiring at all. (For if it’s imminent… our operational requirement will be need a lot more than 65 planes).
A contrived cost accounting does not helpfully inform our choices in the Defence portfolio: we fight wars because – and only because – we have no choice; we have a military because – and only because – we have no choice. (At least, that is what our ethics claim) If we do not seriously believe fighting to ensure the survival of Canada – World War III, etc. – to be a serious problem to prepare against, very well, but that is a qualitative question of geopolitics and strategy – not cost. It is possible we are not in the same category as Belgium of the 1930s – or Canada of the 1950s, for that matter – and that we do not need CF-35s to ensure our survival. We couldn’t predict World War I & II, we coudn’t predict the end of the Warsaw Pact; but no matter, you might still argue we live at the End of History, and that no serious strategic events will confront our international system this century.
Yet we won’t settle the matter either way by counting or monetizing anything.
This is why the Air Force muddled the paperwork: because as Gen. Hillier made very clear in his memoir, they reject the validity of accountants’ conception of what accountability looks like. Against the GAAP, they might point to something like this, wherein ‘tradition’ and ‘honour’ are very tangible, pretty reliable tools for due diligence. Furthermore as anybody can see they simply do not care what Air Power superiority costs over the long run: they think we have no choice. They are not truly interested in a costing or value-for-money weighing because they see the fundamental Air Force mission in Churchillian-Kennedyesque terms, that “we shall pay any price, bear any burden, meet any hardship…” err, you didn’t think that was mere rhetoric, now? To people who spend there careers pondering World War it’s an obvious inference from the reciprocal willingness of ideologues, be it Hitler, Osama, or Kim Jong Un, to spend on our own destruction regardless of cost.
If the stakes for NORAD capability are what the RCAF, by its raison-d’etre and entire tradition assumes them to be – readiness for total war – then for such an ‘accounting by superlatives’ the question is not whether this is a cost-effective aircraft but only whether this is the best possible aircraft. (For what it’s worth, incidently, I strongly suspect they are wrong, but that’s a strategic dissent: for the record I’m a drones & cyberwar kind of guy; radar stealth is so 1988… but that’s an argument for some other blog). Early on, everybody implicitly conceded the JSF by specs was superior because it was the American design project explicitly intended to achieve exactly that: strike fighter superiority, at whatever cost. (Though I gather there’s an increasingly credible engineering argument against the airframe and its development schedule as unrealistically ambitious… but again, that’s not our baliwick either, here). It would be difficult to see how the United States could be described as a superpower if it were not capable of such superiority as a matter of course – so why test an undisputed hypothesis in a competitive tender?
The AG is further aghast at the sunk costs dilemma incurred by signing the original Memorandum of Understanding, but what you might call Social Capital (if we must) really means something to strategists: our greatest sunk cost is our relationship with the United States. Unlike the marketplace, the reciprocal nature of strategic relations means our value includes the sunk costs they carry in their relationship with us. As in the jungle, Loss Aversion, and precautionary bias to the status quo, and defensive preparedness is mostly a sensible heuristic in grand strategy: game theory virtually proves as much. If their aircraft should prove inferior, that implies we must reconsider the efficacy of our Alliance (Why ally with a fading power?) which we are obviously not about to do. We are not Sweden, whatever our neutralist fantasies. So in the meantime, money spent on a North American project recoups to the North American economy and industrial base; we obviously capture more security value by supporting American aerospace research than say, Swedish R&D. In a near monopsony, it is not at all clear that a competitive market blind to geographic origin is possible, or that it would be optimal for the buyer even if it were. Depending on what the industrial strategy is, it may not be in our financial interest to pay the costs to design, build, and field the JSF – but it’s very probably in our interest to have them do it.
The AG complains of a “fair” competition? But why should competitiveness the defining quality of fairness in this portfolio? As George W. Bush notoriously asked Paul Martin about the Missile Defence shield, “Why should I we pay to defend Canada?” The answer is that they have no choice: the U.S. can hardly allow North Korea or whoever to invade and occupy Canada, strategically; they will always defend us. So isn’t there a completely reasonable arguement to be made that a competitive tender to buy somebody else’s aircraft is unfair behaviour? Accounting tells us to ignore sunk costs in the past, and cut our losses when the wind changes; honour tells us something different. It is a historical fact that the value of an alliance grows with longevity. A nation run by accountants and economists risks the costs of political amnesia, incapable of accounting for the chief componant of strategic value: identity. Operationally, it is irrational to try operate a military on an ethos of rational calculation anyways, because warriors will not sacrifice their lives for rational incentives: if you were asked to climb into one of this jets, what’s the cost of your losing your life, to you?
Since in this case the accounting process fails to provide the department a strait-forward means of formulating this case for soul-source approach directly, they attempted to bypass an accounting processes premised on cost estimates in favour of their own strategic process premised on intelligence estimates. That strategic process is, to be sure, unduly informal, ad hoc, and political. There’s nothing in CF doctrine for the strategic planning comparable rigour of the Operational Planning Process, and there should be (a post for another time, perhaps…), but that would almost by definition bind cabinet, and Canadian cabinets react especially poorly to Generals advising them how to go about making decisions. So instead we get campaign promises about armed ice breakers, and this raft of glittering generalities written so generically as to provide no substantive guidance whatsoever to the ordinal sorting of material priorities, let alone buying jets. If you gave a perfectly independent, perfectly rational supergenius from Mars a copy of a) the Canada First Defence Strategy and b) Jane’s All The World’s Aircraft, asking her to pick a fighter jet, what would you get? …right. A very frustrated Martian. So military strategy is thus left open, flexing to the daily news-cycle improvisations of politics – which is how political staff like it.
The RCAF’s attempt to sole-source was not necessarily inept or dishonest – the political communications may have been, but that’s hardly a new problem. Now that accounting is a subjective undertaking, it is easily politicized and so nobody believes anything budget documents say about much of anything anymore. It’s called the Generally Accepted Accounting Practices – but that is to say, generally accepted by accountants, who’s claims and assumptions are simply not subject to nearly enough scrutiny by the rest of us. The conversion from Cash Accounting to Accrual Accounting was taken with little debate at all. The government could have focused it’s political message on the price figures, loudly declared total lifetime cost too unpredictable to stipulate for decades of future service in unknown strategic circumstances, and shaped the rules of the game long before the AG stepped in with a referee’s whistle.
That’s is why the media furor over this process will fail to catch on with the general public. Journalists save up their venom for process inconsistencies, which affords them better pretence of ‘neutrality’ on substantive questions – or at least independence from political players. The public do not share this fascination with process: they care about substance and they like expediency in the public interest just fine, thanks. I suspect this controversy may well accrue to the discredit of the Minister and his party, but subtly, and for real strategic reasons unlikely to find much echo by pundits. Quite sensibly, most Canadians’ real complaint will not really be cost but value: they don’t see it. They don’t see that Russia is still a threat, and they find photo ops suggesting as much to be laughable. They feel history is indeed over, and they don’t bother studying it. They simply don’t believe the survival of the state is at stake in the choices the Defence Department makes, they quite rightly don’t understand what our strategy is supposed to be, and they are deeply suspicious about paying anything for it – let alone whatever the ballooning costs here prove to be.
Says Andrew Coyne: “You could have backed a truck up to the Defence Department and loaded it up with $40-billion, for all our traditional checks and balances were concerned.” Ah, no. Cost ≠ price, and differences of opinion over holistic costs do equate to cash pouring out of the mint. And as for traditional checks and balances on strategy-making… it’s called the Royal Prerogative: they’re aren’t any checks save the confidence of the House. If Parliament wishes to reorient the mission of the RCAF away from great-power total war to some other mission, as was done here in New Zealand, so be it. That has not transpired… nor even been debated, for the most part.
That was not the present government’s platform, however. Contemporary libertarian economic ideology presumes the rational choice model. If they want a does of serious legitimacy, they call up the Big-4 for a re-audit; they will be the very last to question the authority of the Bay St branch plants for Big Accounting. They took every AG’s critique of the previous government for gospel; they promised an ‘Accountability Act’ and an approach to public administration that doubled-down on all the platitudes of technocracy and accountingism.
As Mr. K used to put it in my Grade-13 Politics at Northern: “Power is the ability to set the agenda.” In the Westminster system, such power is shared on both sides of the House. That Oppositions have failed to wield their investigative function effectively is no excuse for the emergence of ‘Celebrity AGs’ whose extraordinary recent influence – empowered by such robustly open-ended abstractions as cost, value, and performance – is effectively unconstitutional, in my view. This latest fiasco only demonstrates why it should be so: we are talking about paper trails, and entirely avoiding the substantive debate we dearly need on what our Air Force is actually for. Weber was right: the moralising of such categorical dilemmas as grand strategy belongs in Parliament, and not left up to unelected public servants whether PWGSC or AG alike. Wilson’s unmeasurable ‘coping’ organisations don’t need more precise – and therefore ever more fictional – cost controls: in the face of uncertainty, they need strategists with better intuition about where the public interest lies, and the courage to stand up and voice it.
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