The Federal Government has not denied reports a major defence project may be handed over to a British firm.

The Defence Minister David Johnston has signalled the Government is looking at awarding a major naval shipbuilding contract to British company BAE Systems.

The troubled Air Warfare Destroyer project is hundreds of millions of dollars over budget and nearly two years behind schedule.

News Corp is reporting the Government wants to sack its own ship builder, Adelaide-based ASC (Australian Submarine Corporation), and give the work to BAE, which operates a shipyard at Williamstown in Melbourne and may lay off more than a thousand workers if it fails to win new contracts within the next year.

However, it is understood that the bulk of the work would stay in Adelaide, but be taken over by BAE at ASC's facilities.

Mr Johnston says no decision has been made yet, but BAE has an exceptionally good record on similar projects.

"They're one of the candidates, they appear to have the credentials," he said.

"I can't go into who's who in the zoo ... but we do need some competitive tension in there. This project is probably one of our most complex ever."

The Prime Minister Tony Abbott has not rejected the reports either.

"It is also important that we get this project completed as quickly as possible with as few cost overruns as possible and, unfortunately, there have been very significant cost overruns, there have been very significant delays, we've got to tackle that urgently and that's what the Government is in the process of doing," he added.

Doubts over local shipbuilding

A Defence discussion paper released yesterday has sparked concerns that future large contracts could be awarded to offshore shipbuilders, threatening a $250 billion industry helping to keep Australian manufacturing afloat.

Sorry, this video has expired SA Senator Nick Xenophon discusses the future of defence manufacturing.

The paper says tough choices need to be made on defence spending, in particular how Australians can get the best value for money to ensure that defence personnel receive the best equipment possible on the available budget.

That is fuelling fears that the Coalition will buy submarines and military ships from overseas rather than build them here.

Australian manufacturing has already been hit by the collapse of car makers Holden, Toyota and Ford with estimates of at least 8,000 job losses, and possibly many more indirect layoffs.

Buying submarines and other defence equipment from overseas would also hit hard.

Up to 12 submarines to replace the locally-built Collins class have been slated to be built by ASC in South Australia, but that is in doubt.

The Federal Government says local manufacturing has performed poorly with inefficiencies, delays and cost overruns in major projects such as the air warfare destroyer.

It has already offered contracts to build two navy replacement replenishment vessel to companies in South Korea and Spain.

'Put on our banana republic T-shirts'

The moves are raising questions as to whether the Government wants a local defence industry at all.

"If it does then it needs to support and partner with it to collaborate and deliver military capability," said Chris Burns, the CEO of the Defence Teaming Centre.

"If it doesn't then let us know. We can put on our banana republic T-shirts, learn how to pick fruit, dig ore out of the ground and serve drinks to wealthy tourists.

"Because, ladies and gentlemen, that's all there will be left for our de-industrialised nation to do."

Speaking at a defence industry conference in Adelaide, Defence Minister David Johnston reiterated the Government's commitment to its target of 2 per cent of GDP for defence spending, but not necessarily spending the money in Australia.

"I emphasise the need for Defence to be able to procure the necessary goods and services in the most efficient way to ensure the ADF can fight and win on the battle field," he said.

The discussion paper will guide the public consultation process for a Defence white paper due to be released next year. Until then, the defence manufacturing industry waits.