The economic consequences of war
How the defence bonanza will reshape the global economy
As they spend big, politicians must resist using one pot of money to achieve many goals
For the first time in decades, the rich world is embarking on mass rearmament.
Wars in Ukraine and the Middle East, the threat of conflict over Taiwan and President Donald Trump’s impulsive approach to alliances have all made bolstering national defence an urgent priority.
On June 25th members of NATO agreed to raise their target for military spending to 3.5% of gdp, and allocated an extra 1.5% to security-related items (Spain insisted on a loophole).
If they achieve that target in 2035, they will be spending $800bn more every year, in real terms, than they did before Russia invaded Ukraine.
The boom goes wider than NATO.
By one estimate, embattled Israel splurged more than 8% of its gdp on defence last year.
Even doveish Japan plans to stump up.
Such vast sums could reshape the global economy, by squeezing public finances and shifting activity within countries.
As politicians sell the benefits of rearmament to voters, many will claim that military spending will bring economic gains as well as security.
Sir Keir Starmer, Britain’s prime minister, promises defence will offer “the next generation of good, secure, well-paid jobs”.
The European Commission says it will bring “benefits for all countries”.
However tempting politically, such arguments are wrong. Using defence spending for economic objectives would be a costly mistake.
The most obvious economic consequence of bigger defence budgets will be to strain public finances.
Debts are already high and the financial pressures on governments, caused by ageing populations and higher interest rates, are mounting.
The average nato member, excluding America, will need to raise annual defence spending by 1.5% of gdp.
As a result other parts of the budget, such as social spending, will be squeezed, shrinking the peace dividend from the ending of the cold war.
And cutting spending or raising taxes by the full amount is likely to be politically impossible, meaning that many governments will run higher deficits, too.
Defence spending will therefore tend to raise interest rates and make the public finances more fragile, even as it makes countries safer from their enemies.
What are the consequences for growth?
Deficit-financed spending will provide a Keynesian fiscal stimulus, but it is likely to be modest—and unwelcome at a time of low unemployment and lingering inflation in the rich world.
Moreover, defence spending is costly and lifts no one’s living standards directly.
Defence research and development, by contrast, could be more beneficial.
Publicly funded innovation often has the effect of spurring private innovation; by one recent estimate, when defence R&D accounts for an additional 1% of an industry’s value-added, its annual productivity growth rises by 8.3%.
Just think of the internet, or nuclear energy, both of which emerged from military research.
Spending on arms will also shift demand around the economy.
Politicians hope that it might counter the effects of deindustrialisation, but they are likely to be disappointed.
Defence production, like much other manufacturing, is now highly specialised and automated, meaning that rearmament is likely to create far fewer jobs than are being lost to new technology or foreign competition.
By one estimate, higher defence spending in European NATO countries could create 500,000 jobs—a paltry number when set against the EU’s 30m manufacturing workers.
The nature of modern warfare only makes mass job creation less likely.
Ukraine shows that a country does not need broad-based industrial policy to prepare for war.
Making drones, which are inflicting the majority of casualties on the battlefield, is relatively simple.
And the more artificial intelligence becomes important, say in guiding and operating those drones, the fewer jobs are created on assembly lines and the more rents accrue to tech firms.
Big defence budgets will present governments with trade-offs between security, efficiency and equity.
As budgets grow, local officials, companies and unions may all clamour for the money to flow their way.
But giving in would be a mistake.
One of the problems with Europe’s defence spending is that too many countries want to make their own hardware.
EU countries operate 12 types of battle tanks, for example, whereas America produces only one.
Duplication is wasteful and hinders armies from being able to work together.
Governments have no duties more important than keeping their citizens safe.
The fragility of the public finances means that they will need to be as efficient as possible in how they spend taxpayers’ money.
Splashing the cash on favoured places and industries will only lead to more tax rises or cuts to social spending.
To make a success of rearmament, governments will need to make an honest case to voters for spending for security’s sake.
If they look to accomplish everything with a single budget, they will do nothing well.
There is no point in boosting growth if the consequence is to be invaded.
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