Construction work on new army infantry vehicles could be carried out overseas, according to reports by the ABC.
The option is being considered by the government in order to speed up the acquisition of the vehicles, with German and Korean companies bidding for the tender told to submit new plans.
Companies had been told to provide options for a build of the vehicles within Australia, or for a complete construction effort from overseas.
Mr Dutton said companies in Australia should be used more as part of defence projects.
"It's a missed opportunity - there are thousands of jobs here in Australia available within the defence industry," he told reporters on the Gold Coast on Friday.
"We have a situation now where the government is stripping back capability from the Australian army, and I think this is why there's a morale problem at the moment in the Australian Defence Force."
The opposition leader said being able to make the vehicles in Australia would enable them to also be exported to other countries as part of the defence industry.
"It's beyond me why the government would want to lose those Australian jobs and lose that industry," the former defence minister said.
"There's a huge multiplier to the Australian economy and in defence material."
Meanwhile, a senior American officer has described the US military as an 800-pound gorilla that overwhelms Australia's slow defences.
In a report called Impactful Mateship, US Army Colonel Alan W Throop says American troops often lack even a simple understanding of how big Australia is and view their forces as "lacking capacity" and easily overwhelmed.
It's something that could trouble or "fracture" the alliance moving forward, with one US personnel member observing "we speak the same language, but we don't".
Australia has just three per cent the number of personnel as the US, something one American trooper said was not common knowledge.
"We have a tendency to overwhelm them ... because we kind of think that they are larger than they are," they said.
Another respondent in the Australian Strategic Policy Institute report heaped praise on the attitude of the ADF while lashing its ability to get things done.
"I've never seen the ADF tell the US side they can't. When they focus on an event, there's nothing (they) can't do," they said.
"They can do one part of it, but they can't do a whole. You can either move here, or you can move there, but you can't do both."
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