At her last fiscal event in March, Rachel Reeves said the government wanted to turn the UK into a “defence industrial superpower”. The chancellor’s statement to the Commons came weeks after the prospective new conservative-led German government stunned financial markets by discarding the shackles of fiscal rectitude and announcing a potentially limitless defence spending fund. Berlin will exempt all military expenditure beyond 1 per cent of GDP from its once-sacrosanct fiscal rules.
In the past month the European Commission has said it will allow member states to borrow to fund defence projects without incurring penalties under Brussels’s debt and deficit limits, an allowance that 15out of the bloc’s 27 economies have said they will use. Next week the EU is also expected to sign off on a €150 billion loan facility that member states can tap to fund weapons, drones and missile defence systems.
The wave of defence spending from countries that have traditionally chosen the welfare state over the warfare state has raised the prospect of a new age of military Keynesianism. That is to say, governments that had prioritised managing their public finances over debt-fuelled expenditure are now turning on the spigot to fund rearmament and bolster their security and defence capabilities. The promise of military spending is not only that it will make Britons and Europeans safer, but in the process the outlays can create high-skilled jobs, reindustrialise regions and provide a much-needed boost to anaemic economic growth and productivity.
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Reeves gave voice to the economics behind defence spending, claiming that the defence strategy would allow companies to “buy, make and sell things here in Britain”. She said she wants “the whole country to feel the benefits” of re-militarisation through “new business opportunities for UK tech firms” and for the money to be used developing “novel technologies like drones and AI” weapons.
The government’s plans for raising defence spending are modest. Labour has initially committed itself to increasing the military budget from 2.3 per cent of GDP to 2.5 per cent by 2027-28, an additional £6 billion to £8 billion that will be funded entirely by slashing the overseas aid budget.
Reeves has said that the target should climb to 3 per cent of GDP in the next parliament, which would amount to a more significant £17.3 billion in additional spending by the end of the decade, according to the Office for Budget Responsibility.
The government is hemmed in by its fiscal rules and is struggling to pull on any growth levers so could beefed-up defence spending emerge as an unexpected source of jobs and prosperity? Is it a welcome or wasteful economic strategy that has been forced on the UK and other western European countries by the second Trump administration?
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Most economists have not spent much time pondering these questions outside the US, which remains the world’s military superpower with a sizeable defence budget. In western Europe defence spending has been a steadily dwindling source of fiscal outlays and military budgets have been slipping from a peak of about 10 per cent of GDP in 1960s Britain to an average of 2 per cent of GDP in this decade.
The revival of the defence and security sector as part of industrial policy, however, is now forcing economists to draw up models to estimate how governments can get the best growth bang for their buck. Paolo Surico, professor of economics at the London Business School, is one of the figures trying to understand the macroeconomics of defence spending and his findings were cited by Reeves at the spring statement. He has been briefing Treasury officials on where to allocate new money for defence and thinks governments should prioritise research and development in defence technologies rather than pouring cash into army recruits and buying weaponry.
Britain should concentrate on building military technologies of the future, experts believe
CORPORAL VINCENT PRICE
Surico told The Timesthat funnelling money to help start-ups to build the military technologies of the future is a “high-risk, high-reward” strategy. “If you want to maximise the macroeconomic impact of defence spending, you need a very significant component of public research and development,” he said. “This has to be focused on domestic and European firms to reap the rewards of a potential productivity boost.” His work cites famous examples such as the US military’s development of the internet and how America’s Defense Advanced Research Projects Agency (Darpa) helped to create the precursor to GPS.
To try to measure the growth impact of government spending, economists use a metric called the “fiscal multiplier”, which models the effect of additional public spending on raising the national income. Surico’s research suggests that traditional military expenditure on personnel and buying equipment has a limited multiplier of 0.6-1 for every £1 spent in the span of about four years but if governments concentrate on research and innovation, the pay-off over decades could create a multiplier effect as large as 2 (where every £10 billion of spending would result in a £20 billion GDP increase).
Long-range estimates of this kind are inherently uncertain though. They rely on state spending unlocking breakthrough productivity-boosted technologies in an age where big leaps in innovation such as the internet and AI are already in train.
The United States is the pin-up example of successful “moonshot” military projects that have become civilian technologies but defence spending in Europe has traditionally had little productivity or technology-enhancing benefits. A recent study from the European Commission found no clear evidence that military spending led to economic growth in 15 European countries over a 50-year span starting in the 1960s.
HMS Vigilant at Faslane, which carries the UK’s Trident nuclear deterrent
JAMES GLOSSOP FOR THE TIMES
Ethan Ilzetzki, an associate professor of economics at the LSE, said a growth dividend was more likely if governments used borrowing rather than tax rises to pay for the spending. Brussels has paved the way with a loosening of its fiscal rules but the UK has not detailed how a potential 3 per cent of GDP defence budget would be financed and the chancellor is already struggling to hit her fiscal rules.
“There’s no guarantee that borrowing for defence can pay for itself,” Ilzetzki said. This is largely because the UK relies on overseas suppliers for about 50 per cent of its defence equipment and the EU for about 75 per cent. Most of this is supplied by US companies, which are likely to be the short-term beneficiaries of larger European defence budgets.
Even if new military expenditure can help to plant the seeds of future technology, the promise that this will create jobs for domestic workers or reverse industrial decline in Britain is a dubious one, Khem Rogaly, a research fellow at Common Wealth, a progressive think-tank, said. He noted that real-term spending on defence had risen marginally since the 1980s but employment in the sector had fallen by half. “Direct and indirect spending from the Ministry of Defence is responsible for only 0.9 per cent of all jobs in the UK,” Rogaly said.
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Rather than attempting military Keynesianism, which would require large debt-funded investment, Rogaly warned that the UK strategy resembled “military austerity” as funds are being pulled from other industrial policy tools such as the National Wealth Fund. “This is not a serious industrial or jobs strategy,” he said.
One potential silver lining from the urgency to fund defence spending in Europe is demands for the EU to take another step towards fiscal federalism. This would involve joint debt issuance from Brussels to pay for common security challenges. Shaan Raithatha, senior economist at Vanguard, said the conditions were perfect for member states to pool their sovereignty to pay for their security needs.
“Procurement would be more efficient and help to reduce fragmentation,” he said. “This is Europe’s second ‘whatever it takes’ moment. A once-in-a-generation opportunity to engage in permanent EU-level fiscal policy.”
