Merlin Weekly Macro: Think like a Ukrainian!

Nothing accelerates technological development like a war.

In the Great War, it was mechanical change: machine guns, tanks, submarines, artillery and aircraft.

The decade spanning 1935-1945 saw almost unimaginable leaps forward: consider the RAF discarding the obsolete bi-planes with which its entire front-line home defence fighter force was equipped, and within 10 years embracing the jet age. Bombs went from small and crude, through the original MOPs (it was Barnes Wallis who invented the first ‘earthquake’ deep penetration bombs, ‘Tallboy’ and ‘Grand Slam’; the Massive Ordnance Penetrator Trump dropped on Iran last month is a   direct descendant) and ultimately, to the Americans having an atomic weapon delivered by a single aircraft capable of annihilating a whole city in a flash. Over the same period, the development of electronic warfare systems (and their countermeasures) was equally dramatic: from negligible and feeble to highly sophisticated, an important part of which was the evolution of the cavity magnetron. It allowed the big step forward propagating high frequency radio pulses whose wavelengths rapidly decreased from being measured in metres to millimetres and accelerated the development and application of radar detection and electronic navigation systems (you use that same technology every day at home in your microwave oven).

The same is happening now, not only because of the Ukrainian war but also the wider power struggle for geostrategic advantage. The real advances and technological breakthroughs are being made in the developments of AI and all aspects of quantum computing and their applications to communications, command and control systems, intelligence gathering and cyber warfare. On the battlefield, accelerating directly because of the Ukrainian and Middle Eastern conflicts, the rapid changes and advancement of drone technology (much of which, while clever, captivating and seductive for treasury departments because it is cheap, compared with advanced systems is still relatively crude and unsophisticated).

Drones: the busy end of the battlefield

It is no exaggeration that on today’s eastern European battlefield, drone designs and delivery systems are adapting in little more than six weeks, let alone six months or six years. It is one of the marvels of Ukrainian technical ingenuity that almost from a standing start three years ago, and simply through necessity and an acute shortage of traditional heavy weapon systems, annual drone production this year is likely to be around 4 million units, double the number manufactured or procured in 2023; President Zelensky told the June NATO summit that Ukraine can produce 8 million units a year with the appropriate foreign financial aid. The Center for Strategic & International Studies (CSIS) describes Ukrainian production as an “ecosystem” in the funked-up, premium-grabbing talk of the tech world; the reality is that it is a widely dispersed cottage industry comprising soldiers in fatigues and flak-jackets armed with screwdrivers, soldering irons and gaffer tape beavering away in bombed-out buildings, underground bunkers, woodland hide-outs, wherever is out of sight and moderately safe from predatory Russian surveillance and attack drones.

In the United States, that same influential CSIS think tank (essentially the US equivalent of the Royal United Services Institute in the UK) has recently published an exhaustive analysis of how Ukraine has achieved this amazing feat of procurement. It looked at whether there are lessons to be learned that can be applied in the US and NATO. Specifically for Ukrainian drone production the essentials of what it identifies can be distilled into four key foundations for success: 1) a hypothecated budget separate from the main defence ministry budget; 2) one third of all defence procurement spending being allocated to R&D, mainly in unmanned systems; 3) procurement authority is not only decentralised but devolved entirely to the battlefield unit level which can demand the technological adaptions it needs rather than simply accepting what it is given; and 4) that by government both authorising and facilitating fast track direct procurement, but otherwise keeping well out of the way other than to guarantee to pay the bills for the finished product, private capital is more likely to be made available in what then potentially becomes a “strong positive feedback loop that rewards speed, effectiveness and adaptation”.

UK procurement: time to shape up or ship out

For UK defence, designed for war but structured for peace, a chronically sclerotic defence procurement system is the enduring weak link in Britain’s defence armour. It has proved impervious to reform for more than half a century: it sucks the life-blood out of the defence budget; it obeys the economic laws of diminishing returns; it provides bad value for the taxpayer; and for the military the bang-for-buck declines year-by-year. It is a rare project indeed that is delivered on time and on budget.

Positively, the 2025 Strategic Defence Review published in June heralds a “Radical root-and-branch reform of defence procurement”. Addressing how efficiently the budget is spent is every bit as important as how much money is available. The Reviewers observed the average time from inception for a new product contract worth more than £20m to be awarded by the UK is 6.5 years. Compare that with the reference we made above to six weeks under battlefield conditions in Ukraine. No time to waste, you’d think.

A new Defence Industrial Strategy is due towards the end of this year and a “collaborative plan” by April 2026. The newly created post of National Armaments Director (NAD) will provide direct leadership under the control of the also new Growth Defence Board, co-chaired by the Defence Secretary and the Chancellor. The armed services will have direct skin in the game: the Chief of the Defence Staff (CDS) will also have co-responsibility for delivery of results alongside the NAD. The current interim NAD is yet to be replaced by the first full-time, specifically appointed director. 

These initiatives are essential. But successful delivery of bang-for-buck requires a fundamental change in mindset from every link in the chain: government, civil service, military and the defence contracting industry. Historically, wherever the problem, top, middle or bottom, it has been habitual for project overruns to be blamed on someone else: nobody takes responsibility or is held to account. Accountability must be crystal clear (the NAD’s remuneration package includes a 60% performance related bonus; failure should mean not only no bonus but no job; a carrot-and-stick performance culture needs to be all-pervading).

This is fundamentally about leadership. It starts at the top with the Defence Secretary and the Chancellor. The NAD and the CDS must have the delegated authority to make things happen, to demolish procurement shibboleths; and if they meet resistance, to have the summary power to remove obstructions. It requires a revolution in thinking, organisation and operation. There must be no taboos or sacred cows. Areas needing addressing include the MoD’s arcane accounting system so that no more “black holes” can sink the defence budget (the National Audit Office attributes the current estimated £17bn “black hole” which might in reality rise to as much as £29.8bn to the decommissioning costs of nuclear systems and the “soaring cost of naval ship building” which over 10 years had increased by “£54.6bn over the original budget”); with significant sums being allocated to estate infrastructure and military housing it also needs to address the egregious intragovernmental charging systems for development, maintenance and repair. The NAD/CDS’s mission must be “Pace! Delivery! Efficiency!”. The message to all, “Shape Up or Ship out”.

17 generations of drone later….

In short the entire sclerotic UK defence establishment needs defibrillation followed by a big infusion of Ukrainian mindset. Failing that, blow it up and start again. Why? Because in a leisurely linear process, it will already have taken nearly two years from the SDR being commissioned in July 2024 to a DEI Collaborative Strategy being delivered in April 2026 before anything gets beyond the drawing board; in context that will represent half the entire duration of the Ukrainian conflict by that time.

An increasing number of senior military figures both here and abroad say there is a high risk of a head-on clash between Russia and NATO within five years. Hoping that the Russians are worn down or their economy collapses and they are incapable of future aggression is no better than waiting for Godot and praying he never turns up. There is already mounting evidence to the contrary: despite all the reports of being bled dry in Ukraine and running out of troops, extensive new military encampments and air installations are being built on the Finnish border and on the border with Estonia: these are not glamping holiday parks for worn-out Russian soldiers and airmen.

A war-winning strategy is to prepare for the worst and hope for the best: that way there is a much better chance that your foe will think better of an attack and will stay at home.

The thrust of the SDR is “NATO First (but not NATO alone)”. It describes Russia as “An Immediate and Pressing Threat”, while China is “A Sophisticated and Persistent Challenge”. The Reviewers potentially fatally underestimate the real risk: that as China and Russia’s strategic aims coalesce and their alliance formalises to the point of the two being indivisible (their joint communique issued on 9 May was powerful and explicit—see Merlin Macro 16 May), there is a significant likelihood that the West will be at war with both simultaneously, not one or the other. China’s massive and rapid military build-up only adds to the necessity to be prepared for all eventualities. 

Procurement and the investment perspective

The UK Review is unequivocal: attracting fresh capital to defence innovation and research, and to production capacity, is key to the UK transforming its means of waging war. The benefit is the anticipated multiplier of technological development creating a “10x” leap in military “lethality” (while “core” defence spending is going to rise from 2.3% of GDP today to 3.5% in 10 years’ time, the bulk of the uplift is in capital spend; day-to-day operating spend between now and the end of the decade sees little increase in real terms and for the Army, there is no plan to increase manpower).

The “lethality” multiplier is largely predicated on unmanned systems, notably for the Army where the Review recommends that force is delivered on a 40-40-20 basis: 40% “reusables” (drones which come home again); 40% “consumables” (shells, missiles, kamikaze drones etc); and 20% “crewed platforms” (i.e. tanks, armour, carriers). Making that comparison with Ukraine and the need for a much more agile procurement system, between 40% and 80% of what the Army is expected to rely upon to fight and win is seeing technological change happening at lightning speed. Without wasting a lot of money, the challenge is to ensure they are equipped with the latest kit, and not hardware and software that is already generations obsolete. It is a formidable task.

Investing in defence is popular again. Defence contractors’ share prices are strong; new defence-related Exchange Traded Funds are being launched regularly. Sustainable funds are shaking off their ESG defence inhibitions and prejudices: over two years to February 2025, the number of sustainable funds investing in defence more than doubled to 44, according to MorningStar Sustainalytics.

How best to harness the power of the City and the wider investment community in the national interest? The requirement is less in the listed sector where quoted companies have easy access to capital through the bond markets. However, new permanent corporate capital is urgently needed for technological innovation and development in the unlisted arena. “Ecosystem” is that favourite buzz-word of the tech sector. The tendency in early-stage tech investment is towards “clique-ism”: its own exclusive ecosystem of the same risk-takers putting up capital and taking all the spoils. National defence really demands a deep pool of capital and as wide a stake in its fortunes in everyone’s interest; given the liquidity constraints of permanent capital in typically unlisted vehicles, the Treasury and regulators should ensure that investment opportunities are as widely-accessible as possible through appropriate structures and with tax incentives to go with them. Keep it simple.

War mindedness: Germany shows the way

Defence production capacity investment is underwritten by orders. Only governments place orders. Ours must make the financial capacity to satisfy procurement orders that meet the national military need, and to facilitate exports for wider commercial opportunity to reduce financial dependence on the UK government. The strategic threat is immediate, its magnitude neither defined nor conditioned by our financial capacity to resist it.

Germany is confronting its huge defence capability deficit, accrued thanks to decades of neglect and under-spend. €100 billion of catch-up investment is budgeted to plug the gap (Germany also changed the constitution to facilitate increased ongoing defence expenditure). Both Chancellor Merz and his efficient and effective defence minister, Boris Pistorius, are literally laying down the law with the defence industry and the machinery of government responsible for procurement: applying one of the longest words in the German language, the new “Bundeswehrbeschaffungsbeschleuningungsgesetz” law will streamline procurement. Speaking to the Financial Times this month, Pistorius said, “We need to get faster. We need to become more effective. We need to throw rules overboard when it comes to procurement and planning. This mindset change is in full swing”.

As co-chairs (never a good idea: one person should be empowered, responsible and accountable) of the Growth Defence Committee, Ms Reeves and Mr Healey, listen to Pistorius: throw the rules overboard and get a move on. Like his predecessor, the Prime Minister talks about putting the country on a war footing. Here’s the winning formula: emulate the determination of the Germans and start thinking like a Ukrainian.

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